Optimal Debt Not Zero
At a recent conference, Michael Boehlje of Purdue University made an interesting comment. He stated that the optimal debt on a farm or ranch business is not zero.
Let’s drill down and examine his philosophy, which tests the paradigms of many in agriculture. First, approximately one third of farms and ranches are debt-free. The average percent equity, or owned assets to total assets, is 84%. Many of you reading this column are probably raising your eyebrow and saying, “Not me! Where are you getting your data?”
First, with the average age of the producer at 58 plus, and 60% of farmland owned by people over 65, the natural lifecycle of a business would indicate many would be debt free.
However, for the commercial farms or ranches, 400,000 of the 2.1 million farms and ranches nationwide, the total debt of $215 billion is much more concentrated. These producers, particularly those in a growth mode, will carry percent equity between 40 and 60%.
For these producers, if earnings (return on assets) are greater than the cost of money, it makes sense to borrow money, particularly when doing a trend analysis. When calculating rate of return on assets, use a cost basis balance sheet because highly appreciated assets increase the denominator and thus lower your rate of return.
One must examine goals and objectives of the business and personal value systems in managing debt. If one is kept awake at night worrying about debt, it is a sign your current debt level is against your internal value system.
Management Tip of the Week:
Guidelines on Percent Equity by Commodity
Grain Producers >50%
Row Crop >50%
Fruit & Vegetables >50%
Editor’s note: Dave Kohl, The Corn And Soybean Digest Trends Editor, is an ag economist specializing in business management and ag finance. He recently retired from Virginia Tech, but continues to conduct applied research and travel extensively in the U.S. and Canada, teaching ag and banking seminars and speaking to producer and agribusiness groups. He can be reached at [email protected].