Are you borrowing money to operate your farm? If you’re a commercial-sized producer, the answer is probably yes. Especially if a new generation is interested in carrying on the family business.

“If you’re planning to transition to the next generation, you’re trying to grow,” said Keith Bodenhausen, community president of the Bank of Gower in northwestern Missouri. “Expansion usually requires that you borrow.”

We called on Bodenhausen and other farm lenders and economists to outline farm debt in our region. We also asked for tips on how you can manage debt to help your farm succeed.

How much debt do you need?

According to USDA, U.S. farm debt fell to $240 billion in 2010, down from $245 billion the previous year. What does that mean to the average farmer?
To get a handle on farm debt, it’s tempting to take the total U.S. farm debt of $240 billion, and divide it by the number of farmers in the U.S., 2.2 million. That gives you $109,090 as the average farmer’s debt. But you might have to look long and hard to find that average farmer.

Our experts suggest that credit needs vary depending on your position within four basic groups. 
•    Farmers who work full-time off the farm don’t usually require much debt.
•    Older farmers with no one in line to take over are winding down. They usually don’t borrow much.
•    Older farmers bringing in the next generation need debt to expand.
•    Young, beginning farmers need financing, but often can’t qualify for loans on their own.

A December 2009 USDA Amber Waves magazine article titled Debt Landscape for U.S. Farms Has Shifted explains that your operation’s size may also determine your credit needs: “Larger farms, with a greater asset base and higher revenues, are now much more likely to use debt than are smaller farms. The majority of smaller farms surveyed indicated that they have sufficient funds to finance their operations.”

Daryl Oldvader, CEO of FCS Financial, a Farm Credit association that provides financing to Missouri farmers, added to the demographic portrait. “About one-half of the farms in the U.S. are debt-free,” he said. “Most are owned by absentee landowners, retirees or investors.”

The Amber Waves article went on to say that farmers in intensively farmed areas including the Corn Belt, Northern Plains and the Southeast have relatively high debt levels compared to other regions.
Mike Duffy, an agricultural Extension economist at Iowa State University, offers a simple explanation for these trends. “A larger operation will borrow more because they have greater expense to cover.”

The case for borrowing
If you subtract out all the retiring, small and absentee landlords who don’t borrow, you end up with a relatively small number of producers borrowing the lion’s share of the $240 billion in farm debt. It’s common for these operations to owe a million dollars or more.

As Oldvader said, “It’s difficult to imagine a growing and profitable commercial-sized farm in today’s environment without some debt.” Doug Hofbauer, CEO of Frontier Farm Credit in eastern Kansas, agreed: “If you’re bringing on another generation, growth to generate additional revenue is likely to be necessary.”

Kevin Dhuyvetter, professor and Extension specialist in farm management at Kansas State University, said debt makes sense for expanding operators. “If your goal is to run an ongoing business, why would you desire to be debt-free?” he asks. “If managed properly, debt is often one of the lowest-cost sources of capital.” 
Dhuyvetter and his fellow K-State economist, Michael Langemeier, work with the Farm Management Association, which provides accounting and economic analysis services for 2,300 Kansas farmers. Langemeier sees more farms moving from one operator to two or three operators as younger generations return to the farm.

“There’s more opportunity these days for more family members to be involved,” Langemeier said. “Being debt-free is not meaningful to these operators. It takes a lot of cash today to buy land and equipment, and you have to incur debt to grow.” 
He worries more about farmers who don’t borrow. “Some farmers have expanded aggressively in the last five years. If they’ve been good managers, their returns are even higher today, so they have all this cash on hand that they can leverage to expand even more. Unfortunately, there’s a group that hasn’t expanded at all, and I’m a little concerned about their future.” 
Farming takes big bucks

No doubt about it, farming is a capital-intensive business. And hold on to your tractor seat—land prices are trending up.
With its rich, productive soil, Iowa land brings some of the highest prices in the nation, and Iowa can be a bellwether for other farm states. Duffy conducts an annual farmland value survey at Iowa State. His most recent findings, released in December, reveal an average 2010 sale price of $5,064 per acre, an increase of $693 per acre over 2009. 
The other experts don’t see that much increase in their areas, but they report that land values remain strong and sales activity steady, with more buyers than sellers available. In addition, land rent prices appear to be rising. 
Dan Coons, executive vice president of the Macon-Atlanta State Bank in northeastern Missouri, holds strong views on renting versus purchasing: “While we consider cash rents to be high, the cost to amortize a loan on the same land at high sales prices costs significantly more.”

Coons recommends that landowners put land on the balance sheet at a conservative value and not change that value for five to ten years. “This allows a farmer to make meaningful comparisons of their debt-to-asset ratio over time,” he said. “When they show increased net worth, it is truly earned.” Coons goes further, suggesting a concept that might seem sacrilege to farmers. “Bankers and many farm economists think we may have lower land prices in our future. Why not sell some acres, reduce debt, ensure your survival and maybe make a little more profit that goes to family instead of debt service?”

Beyond long-term financing for land, farmers also need short-term loans to cover operating expenses. “We have seen operating lines of credit get larger over the past few years and we expect that trend to continue,” Coons said.
Livestock producers need funds for feed and livestock inventory. In eastern Kansas, “Livestock producers tend to carry larger operating lines due to inventory and input costs compared to crop operations,” Hofbauer said. “Of our top 10 largest loans, five are livestock and only one grows crops.” Livestock producers have been more cautious about borrowing recently, he added.
Crop growers need capital to purchase seed, fertilizer, fuel and equipment. Bodenhausen recommends caution when buying new paint. “Be careful to keep equipment investments in line with your level of production.”

While our Farm Credit sources provide loans to thousands of farmers, Bodenhausen’s and Coons’s banks serve smaller areas and fewer agricultural customers. Still, as a Nov. 30, 2010, USDA Economic Research Service (ERS) report, titled Farm Income and Costs: Assets, Debt, and Wealth, pointed out, it’s the nation’s commercial banks, like the Bank of Gower and the Macon-Atlanta State Bank, that collectively continue to be the largest lender to agricultural businesses.

Farm income looks good
No matter where you borrow, and whether you grow animals or plants, things look fairly rosy for farm income these days, making it more likely that you can repay your debt. The ERS report predicted net farm income would rise by 31 percent in 2010 compared to 2009, and total production expenses would rise by just 2 percent.
Livestock producers took a shot to the chin when feed prices shot up in recent years, but they’re catching up. The ERS forecast: “The rise in the value of livestock production (16.6 percent) is expected to be more than five times the rise in the value of crop production (3.1 percent).”

Partly due to these positive trends, farm assets continue to rise faster than farm debt. Are farmers borrowing less, or are lenders tightening credit? It’s probably a combination of both. As Oldvader said, “The current volatile economic environment has made both farmers and their lenders more conservative regarding credit.”

The ERS report offers more details. “Interest rates have declined slowly throughout 2010, while credit has remained available through major lenders. Nonetheless, farm businesses faced tightened credit requirements throughout 2010 as a consequence of increased local collateral requirements and/or shortened loan repayment time periods. While debt capital is likely to be available to highly qualified borrowers at relatively low cost, less qualified borrowers are likely to face higher interest rates.”
While U.S. farm debt declined in 2010, all of the lenders we spoke to report a slight rise in farm lending recently, even though many producers have taken the opportunity during these positive times to pay down debt. “While 2010 started relatively slow, lending activities have reached record peaks as we approach 2011,” Oldvader said. “Loan activity seems to be gaining steam as more producers reflect confidence in the economy.”

Learning from the past
We’ve established that expanding commercial farmers need loans, that credit is available, and that producers have a better chance of repaying loans than in past years. Still, a certain percentage will not make their loan payments. What’s the difference between those who succeed and those who struggle? 
To find the answer, we turn to the farm credit crisis of the 80s. Iowa became the epicenter of the crisis when lenders provided loans based on escalating land values. “People learned that what goes up can come down,” Duffy said. “It only matters that you can make debt payments.”

Both farmers and lenders learned from the crisis. “We learned that you can’t borrow your way out of debt,” Oldvader said. “Even though assets are appreciating today, sound borrowing principles should always center around adequate earnings for debt repayment—liquidity for periods of extreme price volatility and manageable debt levels relative to total assets.”
Hofbauer gets right to the point. “It might take collateral to borrow money, but it takes cash to repay it,” he said.

What lenders want today
Fortunately, our experts think today’s farmers are more savvy than in the past.
“The worst managers see debt as a way to cash flow—they borrow money to pay bills,” Dhuyvetter said. “The best recognize that debt is simply another input, similar to buying seed. Successful debt managers understand how leverage and interest rates relate to financial measures such as return on assets and return on equity. You can keep debt manageable by not over-extending yourself, and by managing production and market risk.”

Honing marketing skills is key. “It’s not necessarily a college degree that makes the difference.” Bodenhausen said that while some farmers might not have attended college, the ones who succeed seek continuing education. “They’re self-motivated to study how markets, contracts and futures work,” he said.

Most large operators depend on accountants to track finances. “If you know your cost of production per bushel of corn, you can make a better decision on when to sell it,” Bodenhausen said.
Beyond understanding financial principles, Oldvader said the best managers develop a business plan that addresses credit use and repayment sources. “These producers also maintain current and accurate records to support constructive dialogues with their lenders,” he said.

If ever there’s a time when you should be able to manage debt, it’s today. Interest rates hit historic lows recently, allowing you to lock in low fixed rates on longer-term debt and low variable rates on short-term operating debt.
“Managing debt today is easier than other aspects of the farm business,” Hofbauer claimed. “Managing the cost and volatility of inputs, marketing decisions and risk management are all more difficult than managing debt.” He believes farmers who fail run into problems in three areas—managing expansion, handling market volatility and controlling expenses. He suggests you ask yourself these questions:

How have you handled growth and expansion?
Have you incurred losses from a production problem or a risk management program gone awry because of extreme market volatility?

Are you living within your means?
Managing debt may be easier, but lenders still want farmers to share in lending risk. That’s why they ask you to invest your own equity capital in your operation—in other words, you must have money to borrow money. “We’re seeing operations grow more rapidly today than ever and funding that growth should come from a combination of earnings/equity and borrowed funds, not just from borrowing,” Hofbauer said. “As operations grow it is critical to maintain capacity and liquidity in the operation.”
Another important skill—working with employees and family members involved in the business. “Managing human resources is even more complex than managing production,” Hofbauer said. “Successful commercial operations focus on having the right people in the right jobs doing the right things.”

Coons believes farmers should build liquidity during good times. “Proper loan structure means keeping a significant portion of your debt long term, and paying down operating lines and machinery debt faster,” he said.
It’s a good time to be a farmer

If you need a loan, and you develop good management techniques, you can probably pay it back. Farmers are enjoying the best profits in decades.

“The mid-1970s was the last comparable period when U.S. farming enjoyed multiple years of sustained levels of high output and income,” said the ERS report. Soybean farmers are benefiting from record exports, especially to China, and corn sales will rise with expected increases in bio-energy demand.

If it’s a good time to be a farmer, it’s also a good time to be a farm lender. Most ag lenders weren’t involved in the worldwide banking crisis a couple of years ago, and they’re well-positioned to provide debt financing.

But Dhuyvetter reminds everyone to stay grounded. “This is a great time to be a farmer—but it’s no time for the faint of heart. There is tremendous variability in markets for both inputs and outputs, and the dollar amounts being managed today are larger. The need to treat the farm operation like a business is more important than ever.”

Bodenhausen throws in a final piece of advice. “Keep costs in line with revenue—and keep on top of it,” he said. “We’ve enjoyed positive commodity prices for a while now, but use more conservative pricing forecasts in your budget. Today, demand is strong and supplies are low, but world events could change that. The market won’t support these prices forever. Use these times of good prices to get your financial house in order.”

Where to get help
The Extension service offers courses on debt management. Contact your local agent, or, in Missouri, visit extension.missouri.edu and click on agriculture. In Iowa, extension.iastate.edu/farmmanagement. In Kansas, agmanager.info.
Farm Credit University offers an online course featuring David Kohl, a nationally respected farm economist. Visit their Web site, fcuniversity.com, or contact your local Farm Credit association. Your community bank can also help.

How do you measure up?

Many farm lenders use three main ratios to measure a customer’s financial health, but in today’s environment, liquidity is the critical measure. Lending on assets that are not easily converted to cash doesn’t work like it used to. Your ratio may vary based on your type of operation, your size and scale, and your long-term business plan. Ask your lender where you stand. 

Liquidity (Working Capital): This compares current assets or capital on hand to debt. Strive for a ratio of 1.25 to 1 or better. For every $1 of current liabilities, you should maintain $1.25 or more in liquid assets. If you owe $1 million in current liabilities, you should maintain $1.25 million in current assets. Current assets include cash, crop or livestock inventories, accounts receivable, and marketable securities such as CDs, stocks and bonds. Current liabilities include obligations due in the next 12 months.

Repayment Ability: The Capital Debt Repayment Capacity Ratio measures your ability to repay loans. Lenders like to see this at 1.25 to 1, where for every dollar you owe in term loan payments, you should earn at least $1.25 in net income for the year. If you owe $100,000, you should make $125,000 or more. Net income is the amount of earnings remaining after you subtract expenses such as labor, fuel, feed, seed, fertilizer, family living costs, taxes and rent.

Debt to Equity: This measures your leverage by comparing your debt to equity levels. At least 55 percent of your assets should be in the form of equity. If you have $1 million in real estate, you should maintain $550,000 in equity or net worth, and owe no more than $450,000.