Recently my travels included a stop to address the FINPACK Lenders Conference in Mankato, MN. Bob Craven, director of the Center for Farm Financial Management, presented summary data from the FINBIN financial database.
The average net farm income of these Minnesota producers in 2008 was $139,466, down from $156,012 in 2007. Referring back to the 1996-2002 era finds aver-age net farm income ranged from $26,823 to $59,721. Comparing this time period to the past two years, you can see that net farm incomes have approximately tripled.
The biggest surprise is the widening range in net farm income from the top 20% to the low 20% of producers in the database. The average net farm income was $426,476 for the top 20%, compared to -$33,206 for the low 20%. When analyzing the data since 2003, the financial extremes have become greater each year.
BREAKING THE NUMBERS down by enterprise, crop farmers' average net income was over $180,000 for 2008, more than four times higher than the 1996-2003 period. Producers who have beef and crop enterprises and those who have just beef farms had the most consistent income pattern. However, the lowest net incomes, generally below $50,000, were for hog and dairy farms. Crop and hog farms demonstrated the most variability in net farm income from 1996-2008, particularly later in the period.
Granted, the producers participating in the FINBIN database are above average; however, this data provides a benchmark to size up economic performance.
THE DANGER OF LEVERAGE
Anyone in the protein or livestock industry knows the downside of high financial leverage. When the debt-to-asset ratio exceeds 50%, equity is below 50% and debt-to-equity level exceeds a ratio of 1:1, it places your business in big league financial operations. When reduced output prices and higher input costs occur, it places your business in late stages of the game, being significantly down on the scorecard.
Ed LaDue, a retired Cornell agricultural finance professor, studied the 1980s farm crisis and discovered financial leverage was the No.1 predictor of business failure during that period. This is due in part to heavy financial obligations resulting in high debt service (for example, principal and interest payments). These payments are considered a fixed cost regardless of the economic environment. Reduced prices and higher input costs squeeze the margins needed to repay the financial obligations.
High financial leverage also reduces flexibility, stifling the ability to adapt or change management practices to improve the bottom line. Competitiveness of highly leveraged businesses is also hindered when compared to those with little or no debt because of the extra interest and principal cost.
Debt becomes a bigger burden particularly in economic cycles with deflationary revenue and asset values because fewer dollars are available to pay a fixed-cost obligation.
Dave Kohl, PhD., Corn & Soybean Digest trends editor, is professor emeritus at Virginia Tech. He's published four books and over 500 articles on financial and business topics. You can reach him at firstname.lastname@example.org.