Editor’s Note: Alejandro Plastina is an Iowa State University assistant professor and ISU Extension economist.

Using anonymous farm level data from the Iowa Farm Business Association, a recent Iowa State University study shows that liquidity problems are more common than solvency problems. The farms in this 

The financial strength of a particular farm operation is assessed with respect to its solvency and liquidity ratings at a certain point in time. Solvency refers to the degree to which all debts are secured and the relative mix of equity and debt capital used by the farm. The total debt-to-asset ratio is the selected relative measure of solvency, and is calculated by dividing the farm’s total liabilities by its total assets.

A “snapshot” of farm business financial performance
According to the Farm Financial Scorecard, a total debt-to-asset ratio above 60% indicates a vulnerable solvency position; a ratio below 30% indicates a strong solvency position, and a ratio between 30% and 60% indicates that solvency should be kept under close scrutiny.

Liquidity refers to the degree to which debt obligations coming due over the following year can be paid from cash or assets that soon will be turned into cash. The current ratio is the selected indicator to gauge the farms’ liquidity, and is calculated as the ratio of current farm assets to current farm liabilities. In this ISU study, a current ratio above 2.0 indicates a strong liquidity position; a ratio below 1.3 indicates a vulnerable liquidity position, and a ratio between 1.3 and 2.0 indicates that liquidity should be kept under close watch. 

Using anonymous farm level data from the Iowa Farm Business Association, a recent Iowa State University study shows that liquidity problems are more common than solvency problems. The farms in this study burned through $92,000 of working capital, on average, in 2015. The full report “Iowa Farms: From Strong to Vulnerable in a Year?” is available on the ISU Ag Decision Maker website as File C1-12.

The financial strength of a particular farm operation is assessed with respect to its solvency and liquidity ratings at a certain point in time. Solvency refers to the degree to which all debts are secured and the relative mix of equity and debt capital used by the farm. The total debt-to-asset ratio is the selected relative measure of solvency, and is calculated by dividing the farm’s total liabilities by its total assets.

A “snapshot” of farm business financial performance
According to the Farm Financial Scorecard, a total debt-to-asset ratio above 60% indicates a vulnerable solvency position; a ratio below 30% indicates a strong solvency position, and a ratio between 30% and 60% indicates that solvency should be kept under close scrutiny.

Liquidity refers to the degree to which debt obligations coming due over the following year can be paid from cash or assets that soon will be turned into cash. The current ratio is the selected indicator to gauge the farms’ liquidity, and is calculated as the ratio of current farm assets to current farm liabilities. In this ISU study, a current ratio above 2.0 indicates a strong liquidity position; a ratio below 1.3 indicates a vulnerable liquidity position, and a ratio between 1.3 and 2.0 indicates that liquidity should be kept under close watch.

Distribution of farms across categories in January 2016, in percent of sample (farm count in parenthesis).

All 316 farms in this study can be assigned to one of the nine categories created when combining the three categories for solvency and three categories for liquidity (table 1). The average farm size in this study is 801 crop acres, and 67% of the farms in the sample are 500 crop acres in size or larger.

In January 2016, liquidity and solvency ratings were simultaneously vulnerable for 17.7% (56 out of 316 operations) of the farms in the sample. Liquidity positions were rated as vulnerable for 36.1% of the farms. Solvency positions were rated as vulnerable for 22.5% of the farms. Therefore, liquidity problems were more common than solvency problems.

The solvency and liquidity ratings were simultaneously strong for 30.7% of the farms in the sample. The liquidity rating was strong for 43.0% of the farms, and the solvency rating was strong for 40.5% of the farms.

Are Iowa farms becoming more financially vulnerable?
The same 316 farms were categorized according to their solvency and liquidity ratings as of January 1, 2015, and the changes in categories for all farms in the sample between January 2015 and January 2016 was analyzed. The total number of farms that did not switch categories between January 2015 and January 2016 amounted to 204, and represented 64.6% of the sample.

1) The most common switch in categories involved a lower liquidity rating while maintaining the solvency classification (16.1% of farms). This is a clear indication that lower commodity prices affected farm operations mostly through liquidity in 2015.

2) The second most common switch involved a lower solvency rating, while maintaining the liquidity rating (6.6% of farms). Farms in this group with vulnerable liquidity classification (12 farms), saw their farm net worth decline 23% on average in 2015, mostly due to operating losses and increasing debt. Farms with a strong liquidity classification (9 farms), saw their net worth decline 6% on average in 2015, due mainly to increased debt levels to maintain their liquidity (several farms in this group also purchased land or machinery in 2015).

3) The third most common switch involved improving the liquidity rating while maintaining the solvency classification (5.7% of farms), mainly through debt restructuring.

How much working capital did farms burn through in 2015?
Working capital is an absolute measure of liquidity, and is calculated as the difference between short term assets and short term liabilities. If working capital is greater than zero, then all short-term liabilities can be paid off by liquidating a portion of the short- term assets.

To provide a reasonable answer to this question, farms were assigned to one of three possible groups according to their liquidity ratings in January 2016: vulnerable, under watch, or strong. Then, the average working capital for each of those groups was calculated using January 2015 and January 2016 data. It is important to note that the number of farms in each group is the same for both points in time because the composition of the groups remained unchanged for this comparison.

On average, these farms burned through $91,658 of working capital in 2015, or 24% of their working capital as of January 1, 2015 (Table 2). However, while farms with strong liquidity ratings in January 2016 burned through $58,445 in 2015 (equivalent to 9% of their working capital in January 2015), farms with vulnerable liquidity ratings burned through $137,149 in 2015, ending up with short term liabilities in excess of short term assets by $44,398. Farms with under watch liquidity ratings burned through $81,520 in 2015, equivalent to 28% of their working capital in January 2015.

Average changes in working capital for farms grouped according to their liquidity ratings in January 2016.

Summing up: This report is a very useful tool to understand where your farming operation is currently standing and to compare it with similar farms in Iowa. Data provided by the Iowa Farm Business Association was very important to this study. This is the first time in nearly a decade these data were available to ISU and it helped tremendously in our efforts to understand the current financial situation on Iowa farms.

Plastina is an ISU Extension economist. Contact him at [email protected]. This is the first in a two-part series appearing in Wallaces Farmer magazine. The first article will appear in the December issue. The second article “What are financially strong farms doing differently?” will appear in January 2017 Wallaces Farmer.