A low-cost/low-debt and a high-cost/high-debt case farm are developed from Kentucky Farm Business Management (KFBM) record data to teach the effect of cost structure and leverage on working capital and profitability. These farms simulate the return over production costs, cash rent, accrued interest, annual principal payments and family living expense over a five-year period. The farms illustrate the liquidity problem facing many of our grain farms across the country and stimulates conversation regarding management alternatives to improve liquidity and solvency.
The low-cost / low-debt farm is assumed to have a current ratio of 1.35 with 50% of debt structured in long-term debt. The high-cost/high-debt farm has a current ratio of 0.80 with 50% of debt structured as current debt. These assumptions are based on the 2014 summary of 225 grain farms participating in the KFBM program.
The farms are assumed to have the same production and sales price to remove production and marketing skills from the cost-structure and leverage discussion. Farm-level yields, production costs, rental rates, family living, and debt payments are from the KFBM data. Grain prices are based on USDA forecasts. When teaching this case study, farmers are encouraged to change the price, yield and cost assumptions to reinforce their understanding that record yields / record prices can not eliminate the liquidity problems.
The case farms provide an environment for farmers to discuss financial problems without revealing any personal information. Management suggestions are incorporated into the simulation to demonstrate the effectiveness on improving liquidity and reducing debt.