By Kevin Brooks
As the Midwest agriculture sector faces another year of low profits, farmers need to take a closer look at their farm balance sheet, which is a snapshot of their financial condition on a specific day. The market-value balance sheet is based on the current value of farm assets owned, liabilities owed, and accumulated interest on liabilities. The difference between what is owned and what is owed indicates farm net worth. A farm balance sheet reveals a great deal about the farm's ability to navigate challenging economic times.
Green, Yellow, and Red Indicators
The market value balance sheet is one of the most critical pieces of information that a farmer will provide to a farm lender. The total of all liabilities divided by the total of all assets is the debt-to-asset ratio, expressed as a percentage. Lenders consider a farm that owes 30% or less of what it owns to be in a strong financial condition (a green light). Farms with a total debt-to-assets ratio falling between 30% and 60% will typically be financially rated in a yellow/caution condition, meaning that more attention will be given to ensure loan repayments are secure, especially at the higher end of the yellow range. The higher the percentage, the greater the concern over debt repayment.
If the loan application falls at the higher end of the yellow range on the balance sheet, other financial measures may be considered in determining the loan rating, and interest rates on loans may be higher. Some banks take on more risk than others and may only approve loans to borrowers with excellent credit scores. A younger farmer is more likely to have a higher debt-to-asset ratio than an older, more tenured one due to having more time to build wealth. Banks cannot discriminate against applicants based on their age; however, they will determine loan risk based on financial factors.
A debt-to-asset ratio of more than 60% will make it challenging to secure a loan through traditional lenders. Approval, if granted, will likely come at a significantly higher interest rate. A farm with a red rating may be directed to the Farm Service Agency of the USDA, as the lender of last resort.
Current Assets and Current Liabilities
Lenders may be concerned about the farm’s ability to pay its financial obligations during the year. The balance sheet categorizes what the farm can currently sell or quickly convert into cash to pay its debts within one year. Current assets include cash, accounts receivable, livestock that will be sold, an inventory of crops ready for sale or in the growing stage, and feed. Current liabilities include accounts payable, operating loan balances, and the current portion of long-term debt. It also includes other obligations, such as accrued interest and taxes that are due during the year.
The current ratio is calculated by dividing the total current assets by the total current liabilities. To achieve a green rating, the current ratio must be at least 2, meaning the farm has $ 2.00 to pay each $1.00 of current debts. A ratio of 1.3 or lower means the operation has $1.30 or less to pay for each $1.00 of debt and is considered risky. A current ratio between 1.3 and 2.0 falls within the yellow rating, as unexpected expenses or decreases in asset values, such as a decline in stored corn prices, could make it difficult to pay current bills.
Source : illinois.edu