How much debt should finance your farm’s assets?
FCC’s Outlook for farm assets and debt 2017-18 provided a picture of the overall financial health of Canadian agriculture using Statistic Canada’s Balance Sheet of Agriculture. Industry financial ratios are indicative of trends, but do not reflect any one operation and are of limited use for benchmarking purposes.
Collaboration between Statistics Canada, FCC and a research analyst leveraged the 2015 Farm Financial Survey (FFS) to paint a more detailed picture of the financial health of Canadian agricultural operations. This post is the last installment of a blog series to help put your farm financials into a larger context and make sense of key financial tools.
Following the overviews of liquidity and debt-service positions of Canadian farms, I examine the degree of leverage in Canadian agriculture, as measured by the debt-to-equity (DE). I find Canadian agriculture operations to be overall financially healthy.
The DE ratio is computed as:
Debt-to-equity (DE)= Total liabilities / (Total Assets- Total Liabilities)
It compares the debt used to finance assets and growth relative to the equity in those assets. A higher DE ratio means larger interest payments and thus higher financial risk. A higher DE ratio is not always problematic if the operation can generate a higher rate of return on equity than the cost of the debt.
How does Canadian farm debt-to-equity measure up?
Canada’s farms showed a supportive degree of leverage in 2015, with an average DE ratio of 0.21. DE ratios varied across the sectors (see the chart below). Grains and oilseeds and beef are sectors with the lowest debt-to-equity positions. Recent appreciation in farmland values explain the low financial risk in the grains and oilseed sectors. More than 8 in 10 beef producers had a DE ratio of less than 0.3. Prudent debt management and a rebounding market for beef allowed cattle producers to build stronger equity positions.
The sectors with relatively more assets financed by debt include dairy, potatoes, and hogs. About one-quarter of all dairy producers had a DE ratio of between 0.4 and 1. More stable cash flows in industries like dairy tend to result in higher liabilities. Dairy may even show healthier DE ratios in 2017 given the recent quota expansion. Debt-to-equity positions of hog and potato producers are likely to have improved in the last couple of years relative to 2015.
Debt-to-equity ratios were strong across all sectors in 2015
How can you use the debt-to-equity ratio?
Maintaining a reasonable leverage position, one that’s suitable for your industry, allows you to increase the potential return of any investments you make. Work with your financial planner to ensure you’re protected from possible changes in Canada’s interest rate environment, and that you’re not missing available growth opportunities.
Amy joined the FCC Ag Economics team in 2017 to monitor agricultural trends and identify opportunities and challenges in the sector. Amy grew up on a mixed farm in Saskatchewan and continues to support the family operation. She holds a Master in Applied Economics and Management from Cornell University and a Bachelor in Agricultural Economics from the University of Saskatchewan.