Purdue Ag economists Mike Langemeier and Mike Boehlje, along with University of Illinois Ag economist Gary Schnitkey, developed a spreadsheet to help farmers determine if they should continue renting land even at unprofitable rental rates.
"One reason farmers continue to rent land, even if they expect it to be unprofitable in a given year, is to retain control of the land in the expectation that profitability will return in the future," says Boehlje. "But how much of a premium should a farmer pay to hold on to a property until profit prospects improve?"
That's the $64,000 question for 2016, with profit margins tight or nonexistent. And it's why we've named this new financial tool as our Spreadsheet of the Month.
The spreadsheet helps tenant farmers weigh factors that may help them decide if a property does not fit the business well – for example, a farm that is 20 miles from the base unit or has rocks or is poorly drained. The spreadsheet helps analyze the farm's financial resiliency and staying capacity if you choose to continue renting land that has a high potential for loss for one or more years.
The spreadsheet lets you plug in various options to determine how much you must pay to maintain control of the land--and then assess the implications of farming this property at a loss on the working capital (defined as current assets minus current liabilities of the business). Here's how it works:
First, determine an economic or "breakeven" rent based on the profit potential given expected future commodity prices, costs and yields.
Second, calculate the "option" premium as the difference between the expected market rent minus the economic "breakeven" rent. This premium will depend on the willingness of the landowner to adjust rents, the competitiveness of the local rental market, and the length of the downturn or speed of recovery in profit prospects for the grain sector. Think of this option premium as being similar to paying someone for an option to purchase a farm or other real estate except, in this case, you are effectively making a payment for the right to continue renting the property.
Third, determine the "burn rate" in working capital that will occur if the property continues to be farmed at a loss. Burn rate, defined as working capital/net income loss, is the length of time in which a firm's working capital will be exhausted by ongoing losses.
Fourth, assess whether the premium (losses incurred) being paid to maintain control of the property will be recovered in future years when margins improve, and whether or not the working capital burn rate is too high for the business to absorb the expected losses without threatening the viability of the business.
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