September 23, 2019
Working Capital & Debt Still Point to a Challenging Farm Economy
By David Widmar
by David Widmar & Brent Gloy
After our earlier post about the USDA’s latest farm income estimates, we got numerous emails from readers. Their questions, broadly speaking, were variations of “is the farm economy really improving?” and “why doesn’t it feel like things have improved?” In this week’s post we provide additional context, including two financial measures – working capital and debt- that signal caution towards the farm economy is still warranted.
To summarize the earlier post, the latest USDA’s net farm income estimates show an improvement in 2019. Specifically, 2019 ($88 billion) is forecasted to be a large improvement over the lows in 2016 ($66 billion). A combination of cost reductions – realized in 2018 and carried into 2019- along with the 2019 MFP program actually pushed net farm income above the 90-year average for net farm income ($85 billion). In that post we also noted the challenges of the ad hoc MFP program. Current estimates have MFP providing $10 billion of support in 2019 alone. This is to say the farm economy in 2018 and 2019 has been propped up by a program with an uncertain future.
In our replies, we also reminded readers of the challenges of using a single measure to draw conclusions on something as large and diverse as the U.S. farm economy. While net farm income is a useful and insightful measure, it – like any single measure – struggles to capture the full story. For example, a shortcoming of net farm income is that it does not capture all the financial obligations of a farm, such as family living expenses or debt service.
In an earlier post, Brent noted that working capital is one of the most straightforward and useful indicators of farm sector financial conditions. Total dollars of farm sector working capital has fallen from more than $160 billion in 2012 to a forecast of less than $60 billion in 2019 (Figure 1). While net farm income has trended higher since 2016, working capital is expected to turn lower in 2019. While the 2019 forecast is admittedly subject to future revisions, the reality is working capital has failed to substantially rebuild over the last four years.
Figure 2 shows working capital as a share of gross revenue. This measure provides context as working capital level – which had been equal to 30% or more of gross revenue during the farm economy boom – has fallen below 15% in recent year. The current forecast is an improvement over earlier 2019 forecasts, but the downward trend is still concerning.
Figure 1. Working Capital, U.S. Farm Sector. 2009- 2019F. Data Source: USDA ERS.
Figure 2. Working Capital to Gross Revenue Ratio, U.S. Farm Sector. 2009- 2019F. Data Source: USDA ERS.
Another balance sheet measure to consider is total debt (figure 3). In 2019, total debt is forecasted to reach $416 billion, up from $402 billion in 2018. Stepping back, this measure has been steadily increasing over the last ten years. In fact, total debt has increased at an average annualized rate of 3.9% since 2010.
Figure 3. Total U.S. Farm Sector Debt, 2019-2019F. Data Source: USDA ERS.
Wrapping it up
While net farm income has shown a story of improvements in recent years, concerns about the farm economy remain. Looking at two-measure from the balance sheet- working capital and total debt- point to troubling realities.
First, producers have been dipping working capital reserves since 2012. Working capital is the first line of defense in an operation’s risk management plan. As working capital depletes, so does producers’ ability to weather future uncertainties. At the same time, producers have also continued to rely on growing levels of debt.
Considering these two measures together, you’re left with the conclusion that producers have been burning working capital and using new debt to bridge financial shortcomings. While this was an expected strategy as net farm income fell from 2014 to 2016, there has not been a pause in recent years; even as net farm income turned higher.
The implications are that net farm income at the sector level has not improved enough to stabilize financial conditions. Even though farm income is currently at levels above the long-run average, there are not enough profits to satisfy all financial obligations. As we noted above, family living and debt service are two large obligations that don’t fall on the income statement but impacts financial conditions.
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