1 KANSAS FARM MANAGEMENT ASSOCIATION Your Farm - Your Information - Your Decision N E W S L E T T E R Volume 6, Issue 3 March 2012 SOURCES AND USES OF FUNDS ON KFMA FARMS A flow of funds report, often referred to as a sources and uses of funds statement, provides a mechanism for reporting how a farm s performance during an accounting period influenced and was influenced by major funding activities. This report reconciles information in the income statement, the balance sheet, and the cash flow statement. Sources of funds include total cash farm receipts, machinery sales, building sales, land sales, net farm loans received, net nonfarm loans received, nonfarm income, and net transfer in. If a farm borrows more money than its reduction in short-term and long-term debt (i.e., principal payments), net farms loans received will be positive. A decrease in accounts receivable from the beginning to the end of the year would represent a net transfer in. Uses of funds include total cash farm expenses, machinery purchases, building purchases, land purchases, net farm loans paid, net nonfarm loans paid, family living expenses, nonfarm expense, taxes, corporation operator labor, and net transfer out. If a farm pays back more money on loans than it borrows, net farm loans paid will be positive. An increase in accounts receivable from the beginning to the end of year would represent a net transfer out. A farm that Also in this newsletter: Long-Term Trends In Liquidity, Pg 5 Solvency, and Financial Stress Crop, Livestock, and Input Price Pg 10 Forecasts from FAPRI Recommendations for Further Reading Pg 12 is growing would typically have relatively higher asset purchases compared to asset sales, and a positive value for net farm loans received. In contrast, a farm that is downsizing, perhaps in anticipation of future retirement, would typically have relatively higher asset sales compared to asset purchases, and a positive value for net farm loans paid. Table 1 presents a summary flow of funds report for the 1,016 KFMA farms with continuous data from 2006 to The layout in Table 1 is similar to the layout contained in a KFMA member s whole-farm analysis report. In the summary report, farm loans received were greater than farm loans paid so net farm loans received was positive. Similarly, total transfers out were greater than transfers in so net transfer out was positive. Machinery, building, and land purchases are also reported as net figures in Table 1. Finally, most KFMA farms do not keep detailed nonfarm income and expense information so Table 1 assumes that the unlocated flow of funds represent nonfarm items. If all cash is accounted for, unlocated flow of funds would be zero. Net cash farm receipts (total cash farm receipts minus total cash farm expenses) ranged from $69,077 in 2006 to $131,438 in Net cash farm receipts were greater than $100,000 in 2008, 2009, and Average net farm income, on the other hand, was greater than $100,000 from 2007 to Net cash farm receipts, along with net farm loans received, were used to purchase assets and for nonfarm expenses (the primary nonfarm expense on most farms is family living expense).
2 KFMA Newsletter, March 2012, p. 2 Figure 1 presents net cash farm receipts (called net receipts in the figure), asset purchases, and unlocated funds for each of the last five years. Unlocated funds (i.e., nonfarm expenses) were above $40,000 in 2008, 2009, and 2010; and ranged from $34,116 in 2007 to $45,918 in Asset purchases at $78,101; $81,659; and $100,765; respectively, were substantially higher in 2008, 2009, and 2010 than the levels in the previous two years. It is obvious from Table 1 and Figure 1 that KFMA farms used the above average income in the last four years to expand their operations. It is important to note that not all farms purchased assets or increased loans over the last five years. Figure 2 presents the percentage of farms with positive net assets purchased and loans paid. Most farms purchased more assets than they sold over the last five years. However, it also important to note that from 44 to 48 percent of the farms in a given year paid down debt. Obviously, numerous farms were able to purchase assets and pay down debt in some years. This would have not been possible without the strong incomes during the last four years. This newsletter article presented historical sources and uses of funds information. I encourage KFMA members and others to take a close look at their flow of funds report and determine what their net cash farm receipts have been used for in recent years. For most businesses, to maintain competitiveness, it is essential that the business grow over time. Net cash farm receipts are an important source of funds that can be used to purchase assets and expand the farm. Michael Langemeier, Professor Department of Agricultural Economics Kansas State University
3 KFMA Newsletter, March 2012, p. 3 Table 1. KFMA Flow of Funds Reports, Item Sources of Funds Total Cash Farm Receipts 433, , , , ,588 Machinery and Building Sales Land Sales Net Farm Loans Received 12,076 10,074 21,683 6,862 28,500 Net Nonfarm Loans Received Nonfarm Income Net Transfer In Total Sources of Funds $446,009 $496,157 $590,365 $567,868 $631,088 Uses of Funds Total Cash Farm Expenses 364, , , , ,550 Machinery and Building Purchases 35,677 41,821 61,868 69,466 83,810 Land Purchases 6,510 9,537 16,233 12,193 16,955 Net Farm Loans Paid Net Nonfarm Loans Paid Family Living Expenses Nonfarm Expense Taxes Corporation Operator Labor Net Transfer Out ,892 3,733 2,660 Total Uses of Funds $408,028 $455,621 $538,330 $514,960 $575,975 Net Flow of Funds Net Flow of Funds $37,981 $40,536 $52,035 $52,908 $55,113 Beginning Cash Balance $37,443 $39,997 $46,842 $55,864 $62,142 Net Flow of Funds $37,981 $40,536 $52,035 $52,908 $55,113 Unlocated Flow of Funds $34,283 $34,116 $43,252 $45,918 $44,698 Ending Cash Balance $41,141 $46,417 $55,625 $62,854 $72,557 Source: Kansas Farm Management Association 2010 Databank.
4 KFMA Newsletter, March 2012, p. 4 $140,000 Figure 1. Net Receipts and Asset Purchases for KFMA Farms, Net Receipts Asset Purchases Unlocated Funds $120,000 $100,000 $80,000 $60,000 $40,000 $20,000 $
5 KFMA Newsletter, March 2012, p. 5 Figure 2. Percentage of KFMA Farms with Positive Net Assets Purchased and Loans Paid 100% Net Asset Purchases Net Loans Paid 80% 60% 40% 20% 0% LONG-TERM TRENDS IN LIQUIDITY, SOLVENCY, AND FINANCIAL STRESS This article uses KFMA data to examine trends in liquidity, solvency, and financial stress from 1973 to In addition, trends in interest rates and loan repayment rates are discussed. Liquidity is measured using the current ratio while solvency is measured using the debt to asset ratio. A farm is defined as financially stressed if return on equity is negative and the debt to asset ratio is above Table 1 illustrates trends in five-year averages of the current ratio, debt to asset ratio, and financial stress from 1973 to Given variability in weather, it is often useful to examine five-year average financial measures rather than examining the averages for a single year. The five-year average current ratio for KFMA farms for was 3.08, which was the highest average over the entire period. Using Table 1, the debt to asset ratio peaked during the period at The average debt to asset ratio for the period, 0.267, was the lowest average since the period. A negative return on equity and a debt to asset
6 KFMA Newsletter, March 2012, p. 6 ratio above 0.70 are used in Table 1 to define financial stress. Return on equity is negative when net farm income is below zero, or when unpaid family and operator labor is less than net farm income. Approximately 34.9 percent and 6.8 percent of the farms had a negative return on equity and a debt to asset ratio above 0.70, respectively, for the period. Combining these two items, approximately 4.4 percent of the KFMA farms were financially stressed during this period. The level of financial stress is substantially lower than that experienced in the mid-1980s, but is still higher than the averages experienced in the 1970s. The percentage of farms with negative earnings and a debt to asset ratio above 0.70 were 45 percent and 15 percent during the period, the peak financial stress years. Farms with negative earnings and/or a high debt to asset ratio are more vulnerable to increases in inflation and interest rates. Currently, agricultural interest rates are relatively low compared to historical interest rates. Table 2 presents annual agricultural interest rates for operating, intermediate, and real estate loans in Kansas from 1988 to Interest rates in the fourth quarter of 2011, the latest quarter available, were 6.28, 6.16, and 5.94 for operating, intermediate, and real estate loans, respectively. A longer term perspective on interest rates is provided in Figure 1 which illustrates trends in the prime interest rate since The prime interest rate has been 3.25 percent since January of The annual prime interest rate has not been this low since The information presented above illustrates that the interest rates faced by producers today are relatively low. If interest rates migrate towards the long-term average or those experienced in the early 1980s, farms with high levels of debt will be financially vulnerable. Given recent monetary policy, many economists predict that inflation will increase rather dramatically when the economy picks up. This increase in inflation would likely lead to substantially higher interest rates. Figure 2 presents a diffusion index of loan repayment rates derived from a survey of agricultural lenders conducted and summarized by the Federal Reserve Bank of Kansas City. Agricultural lenders respond to each survey question by indicating whether conditions during the current quarter are higher than, lower than, or the same as in the year-earlier period. The index numbers are computed by subtracting the percent of agricultural lenders responding lower from the percent that responded higher and adding 100. Thus, a decrease in the index suggests that repayment rates are worsening while an increase in the index indicates that repayment rates are improving. This index has been quite volatile historically, but it is noteworthy that the index has been above 100 since the third quarter of The relatively weak U.S. economy and the failure of policy makers to address long-term issues related to Social Security and Medicare has increased uncertainty. Fortuitously, KFMA farms, on average, are in a relatively strong position to weather the financial storm. Having said that, it is particularly important during uncertain times, to use benchmarks of key financial measures to gauge a farm s competitive position and have a contingency plan that addresses a scenario in which interest rates are substantially higher than current levels. Michael Langemeier, Professor Department of Agricultural Economics Kansas State University
7 KFMA Newsletter, March 2012, p. 7 Table 1. Trends in Liquidity, Solvency, and Financial Stress. Current Debt to Financial Years Ratio Asset Ratio Stress % % % % % % % % % % % % % % % % % % % % % % % % % % % % % % % % % % Source: 2010 KFMA Databank.
8 KFMA Newsletter, March 2012, p. 8 Table 2. Historical Agricultural Interest Rates. Operating Intermediate Real Estate Year Loans Loans Loans Source: Federal Reserve Bank of Kansas City, Kansas rates.
9 KFMA Newsletter, March 2012, p Figure 1. Prime Interest Rate Source: Board of Governors of the Federal Reserve System
10 KFMA Newsletter, March 2012, p Figure 2. Loan Repayment Rates, Diffusion Index Source: Federal Reserve Bank of Kansas City CROP, LIVESTOCK, AND INPUT PRICE FORECASTS FROM FAPRI Long-term price forecasts are often useful for planning purposes. With this in mind, this article briefly reviews some of price forecasts put together by FAPRI (Food and Agriculture Policy Research Institute) in their latest U.S. Baseline Briefing Book (March 2012). Table 1 presents prices for the current or most recent year, and five-year average forecasted prices. The FAPRI baseline presents forecasted prices for 10 years. The five-year averages in table 1 are computed using the first five forecast years in the baseline. Note that crop prices, with the exception of alfalfa, are forecasted using crop years rather than calendar years. Alfalfa, livestock, and input price forecasts using calendar years. It is important to also note that the crop year prices for the current year for all crops except alfalfa contain a mixture of actual and forecasted prices. All of the crop prices are projected to be lower for the 2012/2013 through 2016/2017 crop years than they were for the 2011/2012 crop year. Soybean has the lowest expected percentage decline in price at 2.0 percent. Wheat is
11 KFMA Newsletter, March 2012, p. 11 expected to be 17.0 percent lower while corn and grain sorghum are expected to be 19.5 and 20.7 percent lower, respectively. After seeing extended periods where prices were below breakeven, the higher forecasted prices for feeder steers and fed cattle in table 1 are definitely welcome news. Feeder prices (Oklahoma City prices for 600 to 650 pound steers) and fed cattle prices (5-area direct steer prices) are expected to be 12.8 and 9.1 percent higher, respectively. Beef cow inventories are expected to bottom out in 2013 at 29.9 million head and then slowly start to increase. Input prices for production items (which include purchased inputs such as seed, fertilizer, herbicide, fuel, etc.) are expected to increase by 4.8 percent while wages are expected to increase 6.7 percent. Interest rates, which are currently very difficult to predict, are expected to increase by approximately 16 percent. A broad examination of the relationship between input and output price forecasts, suggests that enterprise net returns, with the exception of those for beef cattle, are expected to tighten. The expected increase in output prices for beef cattle and expected decrease in feed grain and alfalfa prices is noteworthy. Of course, it is important to note that there are a plethora of factors that would change the longterm forecasts discussed above. Some of the most important factors include biofuel policies, GDP growth, and interest rates. Tax credits and tariffs for biofuels are assumed to be zero from 2013 on. Interest rates are expected to increase rather sharply, but remain below the high interest rates of the late 1970s and early 1980s. Finally, real GDP, after increasing to 1.8 percent in 2011 is expected to average 2.8 percent from 2012 to Michael Langemeier, Professor Department of Agricultural Economics Kansas State University
12 KFMA Newsletter, March 2012, p. 12 Table 1. Forecasted Crop, Livestock, and Input Prices. Item Current Forecast Change Crop 11/12 12/13 16/17 % Alfalfa ($/ton) % Corn ($/bu) % Grain Sorghum ($/bu) % Soybeans ($/bu) % Sunflowers ($/lb) % Wheat ($/bu) % Livestock % Barrows and Gilts ($/cwt) % Feeder Steers ($/cwt) % Fed Cattle ($/cwt) % Milk ($/cwt) % Inputs % Production Items (Index; 90 92=100) % Interest (Index; 90 92=100) % Wages (Index; 90 92=100) % Source: FAPRI, University of Missouri, U.S. Baseline Briefing Book, March RECOMMENDATIONS FOR FURTHER READING The purpose of this section of the newsletter is to briefly discuss articles and web sites that may be of interest to readers. In general, the articles discussed will not report on original research. Rather, the articles will contain citations to web sites and articles that discuss topics of general interest. Bernard Ferrari has recently written an article for McKinsey Quarterly entitled The Executive s Guide to Better Listening. Even if you are not an executive or do not employ individuals, you should find this article interesting. Listening is something that often needs to be worked on because it is important to be a good listener to gather relevant information for decision making. The author indicates that it is important to show respect for conversation partners, spend less time speaking, and challenge assumptions that inform conversations. More information is available in the article which is posted on my contributor site on Ag Manage under Recommendations for Further Reading. T. Kirk White and Robert Hoppe from USDA-
13 KFMA Newsletter, March 2012, p. 13 ERS have recently written an information bulletin entitled Changing Farm Structure and the Distribution of Farm Payments and Federal Crop Insurance which documents that commodity payments and crop insurance indemnities have shifted to larger farms. These large farms are producing an increasingly larger share of U.S. agriculture production. Since larger farms tend to earn higher household incomes, the shift in the distribution of payments has contributed to the incomes of larger farms. The article notes that 25 percent of commodity payments went to farms with a household income greater than $209,000 in More information can be obtained from the article which is posted to my contributor site on Ag Manager under Recommendations for Further Reading. A recent article entitled How is Land in the United States Used, written by Cynthia Nickerson and Allison Borchers, documents the use of agricultural land from 1949 to U.S. land area covers 2.3 billion acres. The proportion of land used for forestland and grazed, for pasture and range, and for cropland has declined from 63 percent in 1949 to 51 percent in In 2007, 127 million acres were in grazed forestland (down 52 percent from 1949), 614 million acres were in pasture and range (down 3 percent from 1949), and 408 million acres were in cropland (down 17 percent from 1949). More information, including a map containing the distribution of major land use types by state, can be obtained from the article which is posted to my contributor site on Ag Manager under Recommendations for Further Reading. Michael Langemeier, Professor Department of Agricultural Economics Kansas State University The Kansas Farm Management Association (KFMA) Newsletter is distributed monthly to provide farm management information to farm decision makers. Further farm management information can be found on the KFMA program website: and, on the Extension Agricultural Economics website: The Newsletter is edited by Michael Langemeier, Professor, Department of Agricultural Economics, Kansas State University. Kansas State University Agricultural Experiment Station and Cooperative Extension Service. K-State Research and Extension is an equal opportunity provider and employer. Issued in furtherance of Cooperative Extension Work, Acts of May 8 and June 30, 1914, as amended. Kansas State University, County Extension Councils, Extension Districts and United States Department of Agriculture Cooperating, Gary Pierzynski, Interim Dean and Director.