Working Capital and Financial Solvency Trends • farmdoc daily

Many of you are preparing financial statements for 2022. It is important to take the time to prepare a complete and accurate set of financial documents including an adjusting income statement and a balance sheet. These two documents…or better yet, a series of these two documents dating back several years provide valuable financial information about your farming business. The operating income statement measures the net income that results from the fruits of your management skills and the local/global economic environment in which your farm operates. Your balance sheet (at fair market value or FMV) is a measure of the “stock” at any given time (usually December 31, 20xx) of your farming business assets and ownership rights (via debt or equity) over these assets. Nothing replaces a good set of financial documents that can be used to make decisions.

This article reviews working capital trends in relation to the debt-to-asset ratio. This data, over a period of fifteen years (2020-2006), is provided by farms participating in the Illinois Farm Business Farm Management Association. Working capital is obtained by subtracting current liabilities from current assets. The observations are divided into four groups according to the debt-to-asset ratio. The four debt-to-asset ratio groups are: 1) less than 0.20, 2) 0.21 to 0.40, 3) 0.41 to 0.70, and 4) greater than 0.71. Remember that the debt-to-asset ratio reveals the percentage of your assets that your lender owns. The calculation takes total farm debt and divides it by total farm assets. For example, a debt-to-asset ratio of 0.25 indicates that for every $1,000 of assets, there is an obligation to a lender of $250 on those assets. Debt-to-asset ratios tend to be higher among young farmers who are early in their farming careers. Similarly, debt-to-asset ratios tend to be lower for older farm operators because the seasoned farm operator has had a lifetime to pay off debt originally incurred at a younger age.

Table 1 shows the median working capital for each of the four debt/asset groups for the fifteen year period. For three of the four groups, working capital was at its highest level in 2020. The same three groups show the least working capital in 2006. It is easy to note in the table the trend towards higher debt/asset high associated with less working capital. Additionally, each of the fifteen years shows a decrease in the amount of working capital as the debt-to-asset ratio increases, with the largest debt-to-asset ratio group showing negative working capital in six of the fifteen years.

Working capital is the short-term reserve of cash or cash equivalents that allows a farm business to meet its ordinary financial needs or take advantage of opportunities to expand its farm business. It is necessary to maintain an adequate level of working capital to deal with the vagaries of financial cycles and economic conditions. Adequate amounts of working capital depend on many factors, including the size of the farm operation and the financial and operational risk associated with the farm. As an absolute dollar amount, it is difficult to compare working capital between farms. Table 2 is presented to assess working capital from a relative perspective. Table 2 shows working capital versus acres and working capital versus gross farm income. Many suggest that working capital to gross farm receipts should be between 0.15 and 0.25, or even higher. Table 2 indicates that farms in this data set maintain working capital to gross farm receipts at a level that exceeds the 0.15 to 0.25 level. This measure was at its maximum in 2012 (0.520) and at its minimum in 2006 (0.325). Farmer’s working capital per acre peaked in 2012 ($540/farmer’s acre) and declined significantly to the 2017 level of $281 per farmer’s acre, but began to decline. increase slightly.

Table 2 also shows the median debt to asset ratio for each year with the lowest ratio in 2012 and the highest in 2006. The median amount of working capital is present in this table along with the highest amount of working capital. working capital in 2012 and the least in 2006. Interestingly, in Table 1, 2020 has the highest working capital for the three smallest debt-to-asset ratios.

The authors would like to point out that the data used in this study come from local farm management associations (FBFMs) in the state of Illinois. Without their cooperation, information as complete and accurate as this would not be available for educational purposes. FBFM, with more than 5,500 farmers and 68 professional field staff, is a nonprofit organization available to all Illinois farmers. FBFM staff provide advice as well as record keeping, farm financial management, business entity planning and income tax management. For more information, please contact the FBFM State Office located in the University of Illinois Department of Agricultural and Consumer Economics at 217.333.5511 or visit the FBFM website at www.fbfm.org.