Internal managers, agricultural lenders, external farm managers, and financial analysts often use financial ratios to assess

the financial condition and performance of farmers. There continues to be a desire among these users to gain better

understanding and insight regarding the current financial position of individual producers. Moreover, these measures may

also provide an indication of future financial condition and performance. Six financial measures often used to assess financial

condition and performance are measured and reported across five age groups of farmers. These findings allow users to

focus on the relationships between producer life stages and measures of financial performance.

2007 JOURNAL OF THE A|S|F|M|R|A17

Abstract

Farm financial performance measures are evaluated for producers across five age groups. The debt-to-asset ratio is

highest for farmers in the lessthan- 30 age group, 45.5 percent, and decreases across age groups. Repayment

capacity is strongest for farmers in the less-than-30 age group, 2.1:1, and weakest for farmers in the 50-59 age group, 1.3:1.

Operating profit margins tend to increase as farmers become more experienced. A key element in the financial evaluation of

farmers through the life cycle is differing degrees of land ownership. Paul N. Ellinger is an associate professor in the

Department of Agricultural and Consumer Economics, University of Illinois. He is on the board of directors for the

Farm Financial Standards Council. He holds a PhD in finance from the University of Illinois Freddie L. Barnard is a professor

and Extension economist in the Department of Agricultural Economics, Purdue University. He is a member of the Technical

Committee for the Farm Financial Standards Council. He holds a PhD in agricultural economics with a specialty in

agricultural finance from the University of Illinois. Christine Wilson is an associate professor in the Department of Agricultural

Economics, Purdue University. She holds a PhD in agricultural economics with specializations in agribusiness

management, agricultural finance, and marketing from Kansas State University.

Background

Due to the household-business integration of most farms, the life cycle of family firms is closely linked to the life cycle of

the manager. A typical life cycle for a household-farm operation transitions through four general stages – establishment of

the business entity, growth, consolidation, and transfer (Barry, et al., 1999). The manager’s objectives are likely to change

over these stages of the life cycle. Hence, performance measures are also subject to change.

It is generally assumed that younger farmers have a higher level of risk than older farm operators, as evidenced by relatively

unfavorable solvency measures. As such, agricultural loan officers often concentrate on reducing the level of credit risk for

that group of farm borrowers through loan guarantees (family members and Farm Service Agency), crop insurance, off-farm

income, etc. As managerial ability improves and utilization of management capacity is maximized, firms tend to seek growth

opportunities. Leverage is often used by producers through the growth and consolidation stages of the life cycle.

For many Midwestern grain farms, farmland is the primary asset acquired during the growth and consolidation period.

Farmland provides a current cash return as well as a capital return from increases in market value. As farm operators

continue to invest in farmland though their life cycle, they experience a trade-off between current cash returns on invested

assets and unrealized capital gains on assets. Specifically, as farmers own a higher percentage of the land they operate, a

higher proportion of their total return will be unrealized capital gain. Profitability-based financial performance measures

typically only capture the cash returns. Thus, some profitability measures will likely decline as a farm transitions through the

stages of its life cycle since a higher proportion of the return is unrealized capital gains.

As farms enter the transfer stage, expansion and income generating capacity become less important than assuring a

stable source of retirement income. Farm borrowers who fall into older age groups generally have stronger solvency

measures and, therefore, are assumed to have a lower level of credit risk. Farmland also comprises a large proportion of their

asset base. Risk assessment and performance measures commonly used by agricultural lenders and endorsed by the Farm

Financial Standards Council (FFSC) are calculated using data reported on the balance sheet, statement of cash flows, and

accrual-adjusted income statement. Information used to calculate profitability and repayment capacity measures is

sometimes taken from schedule F of the income tax return. However, using schedule F for analysis purposes can be

misleading because it is commonly prepared on a cash basis. A more accurate measure of profitability for a farming

operation can be obtained from an accrual-adjusted income statement (FFSC). Research findings support this

recommendation. A study conducted in 1992 at the University of Illinois of 369 farm records for the 1986-1995

period found that the average annual percentage difference when net farm income is calculated using cash accounting as

opposed to accrual-adjusted income statements was 69.7 percent for all farms in the sample. That difference increases to

141.3 percent for farms with a debt-to-asset ratio over 40 percent (Lins and Ellinger, 1992). A more recent study conducted

at the University of Illinois in 2004 found that three-year average tax return measures deviate 24 percent from three-year

average accrual-based measures for measures of profitability (Ellinger, 2004).

The objective of this study is to report the magnitude of variance among the financial measures commonly used to

assess risk and performance across the life cycle of a farm business. Wealth and liquidity are expected to increase as farm

managers become older. Repayment capacity will likely follow a U shape. Lenders presumably restrict the amount of term

debt to purchase fixed assets until a track record of strong management can be established. As leverage increases during

the growth stages, repayment capacity will likely decrease due to the added debt burden. As farms enter the transfer stage

of the life cycle, decreasing debt will result in stronger debt repayment measures. The specific objective of this paper is to

measure the extent to which these relationships occur across a group of Midwestern farms.

Procedure

Six financial measures were used to evaluate the farm operators who were grouped by age. FFSC categorizes financial

performance measures across five categories: liquidity, solvency, repayment capacity, profitability, and financial

efficiency. The six measures used in this study addressed one component from each category and two from profitability.

Specifically, they evaluate the current ratio (liquidity), debt-toasset ratio (solvency), term debt and capital lease coverage

ratio (repayment capacity), rate of return on farm equity (profitability), operating profit margin ratio (profitability), and

interest expense ratio (financial efficiency). Two of the measures (current ratio and debt-to-asset ratio) were calculated

using data reported on the balance sheet. Three measures (profit margin, interest expense ratio, and term debt and capital

lease coverage ratio) were calculated using data reported on an accrual-adjusted income statement and a statement of cash

flows. The rate of return on farm equity is based on measures reported on the income statement and balance sheet. The six

measures are evaluated for farm operators who are less than 30 years, 30-39 years, 40-49 years, 50-59 years, and over 60

years of age.

Data

Data used in the analysis date from the years 1995 to 2004 and are taken from the Illinois Farm Business and Farm

Management (FBFM) record-keeping program. The FBFM field staff work with individual producers to document production

and financial data for farming operations. While over 6,500 farm operators participate in the record-keeping program,

approximately 2,000 records satisfy reconciliation and completeness criteria with enough detail to compute the

financial performance measures suggested by the FFSC. Those records are then verified for accuracy before being certified

as usable for inclusion in an annual publication entitled Financial Characteristics of Illinois Farms. The data used in this

analysis are 10-year averages.

Financial Measures

Current Ratio

The FFSC recommends two measures of liquidity: the current ratio and working capital. It is inappropriate to compare the

absolute value of working capital (current assets minus current liabilities) across age groups due to differences in farm size.

Consequently, the focus of this analysis is on the current ratio defined as current assets divided by current liabilities. Assets

are appraised using the market value approach while the current liabilities do not include contingent or deferred tax liabilities.

The median values for the current ratio across the age groups are reported in Table 1.1 The ten-year median current ratio for

all farmers is 1.63.2 The median current ratio for operators 60 years or over, 2.43, is clearly the strongest of all age groups.

Typically, these operators have scaled back on major capital purchases and have become more concerned with the

preservation of equity. In addition, farmers in this age group prefer to hold assets in a more liquid form for retirement, estate

planning, and health care purposes. The second highest median current ratio, 1.74, belongs to farm

operators in the youngest age group, less-than-30 years of age. One possible explanation posits that operators in this age

group are probably accumulating liquid assets for investment opportunities in the anticipation of purchasing land, machinery,

and other capital assets. Likewise, they have not yet accumulated large amounts of term debt, which result in large

principal payments classified as current liabilities. The current ratio is lowest, 1.48 to 1.50, for farmers in the other

three age groups. This position likely owes much to the fact that farm operators in these age groups have expanded their

farming operations by purchasing land, machinery, and other major capital assets. In addition, farmers in these age groups

are usually in the process of expanding their operations and require additional working capital.

Debt-to-Asset Ratio

The FFSC recommends three interrelated measures of solvency: debt-to-asset ratio, equity-to-asset ratio, and debt-to-equity

ratio. The measure used in this article is the debt-to-asset ratio, defined as total liabilities divided by total assets. Again,

assets reported are valued using the market value approach, and contingent tax liabilities are not included in total liabilities.

The ten-year average median debt-to-asset ratio for all farm operators is 30 percent. The debt-to-asset ratio decreases

across age groups, from youngest to oldest. The ratio is highest, 45.5 percent, for farmers in the less-than-30 year age

group. The measure then decreases across the middle three age groups, from 40.4 percent for the 30-39 year age group to

30 percent for the 50-59 year age group. As expected, the ratio is lowest, 16 percent, for the 60 and over age group. This

trend demonstrates the ability of farm operators in the over 60 age group to pay down debt, accumulate retained earnings,

and accumulate valuation equity as a result of market valuation increases for