In the last column I discussed the changing financial performance landscape, zoning in on return on assets (ROA) based upon the FINBIN data sets. Now let’s move on to operating margin and term debt coverage.
Operating margins are being squeezed when one examines the operating expense to revenue ratio. This ratio is calculated by dividing operating expense (excluding interest and depreciation) by total revenue. Further analysis finds margin compression is much more prevalent among the average and below-average groups of farmers in the FINBIN database. For example, in the average group the ratio has crept up from the low 70s to 80% for 2009 data. The low-20% group shows very disturbing results, where the operating expense to revenue ratio has increased from 85% to over 100% – a negative margin. The top-20% grouping has observed an increase, but only by 4 points, from 63% to 67%, which still provides for strong margins.
This margin squeeze is the result of the “bid up” of high cash rents across the board. Cost creep in inputs along with flat or declining commodity prices result in a negative double-team on margin.
The coverage ratio compares the repayment capacity (cash available for debt servicing) to current principal and interest payments. It bears mention because it is one important factor closely watched by ag lenders when extending credit.
The top 20% is still strong, above 200%, providing large cushions for adversity. The average segment’s ratio has declined from well over 200% to 113%, which is in the caution range for most lenders, excluding the Farm Service Agency (FSA). The low 20% moved into negative range two years ago with a rapid decline. This group will continually have to rely on refinancing of operating money to term debt, and sales of capital assets for survival. The consequence is loss of equity, which, unfortunately, is the retirement program for many producers.
Editor’s note: Dave Kohl, Corn & 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@example.com.