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Extension > Agricultural Business Management News > August 2015

Friday, August 28, 2015

Liquidity is Strength when Profits are Scarce, How Should it be Measured?

by Don Nitchie, Extension Educator

Liquidity has certainly become a hot topic that many people are monitoring in Agriculture with more than two years of significantly lower grain prices.  While livestock operations enjoyed strong returns in 2014 many crop only farms experienced negative returns.  Lower prices also impact the value of grain inventories held as current assets on balance sheets.  In some cases, current liabilities may have also increased as operating loans expanded after decreasing over past years of higher grain prices.

In this changing environment, we know that liquidity, or the ability of the farm business to meet its current financial obligations in the coming year is very important.  Strong liquidity also provides a business the ability to withstand short-term shocks and the flexibility to capitalize on opportunities.  But, what is the best measure of liquidity?  Frequently, the current ratio; current assets divided by current liabilities may have been used in the past to measure your liquidity.  Current assets are typically grain and marketable livestock inventories as well as some cash and prepaid inputs.  Current liabilities are typically annual operating loans and annual payments due on machinery, buildings and land loans. A ratio of 2:1 or above is good and 1.3:1 or below is considered weak.

However, while the current ratio is accurate in telling you the relationship on your balance sheet of your current assets to your current liabilities, it does not relate to your income statement and your size of business.  Many financial experts including the Farm Financial Standards Council now argue that the Working Capital to Gross Revenue measure is a much better measure of liquidity.  Working capital is equal to current assets minus current liabilities.  If Working Capital is 30% or more of Annual Gross Revenues, liquidity is considered strong.  If working capital is 10% or less of gross revenues it is considered weak.

As an example, consider a farm where the current assets are $200,000 and Current Liabilities or debt is $100,000.  This would make the current ratio 2:1, fairly strong by conventional wisdom.  The working capital of this farm is $200,000 -  $100,000 = $100,000.   If the annual gross revenue were $300,000, this means that working capital was 33% of gross revenue-strong according to guidelines.  But, if gross revenues were $1,000,000 annually the working capital would only be 10% of gross revenues and the liquidity situation would not be good.  It would be a struggle to meet current obligations.  So relating your liquidity to the size of your operation is important and should be monitored continuously.  Maintaining strong liquidity will help a farming business survive and thrive in challenging times.

Tuesday, August 4, 2015

Relationship between Corn and Bean Prices verses Land Values and Rents

By David Bau, Extension Educator

I receive many questions daily about land rents and land values and what direction they are going in the near future and long term.  Corn and soybean prices have fallen from record highs in recent years to a level that presents a challenge for farmers to generate a profit. I thought I would try to put together a chart that correlates the relationship between these three items.

I put together a list of average farmland values in Southwestern Minnesota from 1994 thru 2014 average Southern Minnesota cropland cash rental rates and average prices received by farmers for corn and soybeans sold each year.  Next I took the percentage yearly change for each and compared the results to each other in Table 1 below. The average change in land values is indicated by diamonds, the average change in Farmland Rental Rates is indicated by squares and the average change in corn and soybean prices is indicated by triangles.

Table 1.

From 1994 to 1995 all three had increases in values with corn & soybean prices increasing by an average of 32.9%, while farmland sales prices increased by 8.4% and farmland rental rates by 5.3 %.  In 1996 farmland sales prices declined by 1.3% while corn and soybean prices increased by 4.1% and rents by 7.9%.

In the last 20 years, there were seven years where corn and soybean prices were negative, while farmland sale prices and farmland rental rates were in negative territory three years.  Is there anything to learn from the chart? There is a trend between all three with corn and soybean prices the most volatile, followed by farmland values and with farmland rents more stable.  There is definitely a year or two lag in the reaction of farmland sales and rental rates following the direction in corn and soybean prices.

From 2013 to 2014 farmland sales declined by 10.7% and farmland rents declined by .9% while corn and soybean prices declined by 15.7%.  With corn and soybean prices in negative territory, this should indicate lower farmland sale prices and lower farmland rental rates unless prices go up dramatically in the near future.
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