FARM-LEVEL EVIDENCE ON THE FINANCIAL GROWTH PARADIGM

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FARM-LEVEL EVIDENCE ON THE FINANCIAL GROWTH
PARADIGM

• Cesar L. Escalante
• University of Georgia
• 21st Annual Southeastern Agricultural Lenders
  School (SEALS)
• April 27, 2004

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The Financial Growth Paradigm

• A business growth strategy could be either
• an operations or
• capital management decision
• Greater growth potential only if the farm
  business performs well in both of these
  interdependent categories of farm management.

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Revenue Enhancement
Profit
Asset Management
Operational Management
Capital Management
Debt Management
Cost Reduction
Assets Generate Revenues
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TWO EMPIRICAL EXAMPLES

• Business Growth Strategies of Grain Farms
• Escalante and Barry, 2001
• Financial Management Characteristics of
  Successful Farm Firms
• Plumley and Hornbaker, 1991

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Farm-Level Evidence 1Business Growth
Strategies of Small and Large Grain Farms

• MOTIVATIONS
• Increasing income risk
• Farm size and business growth
• Heterogeneity of farm operating and asset
  structures among small and large farms
• Inherent differences in choice set of business
  growth and risk management strategies

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Analytical Model

• Panel data of 52 Grain Farms,
• 1995-1999
• Size Measure USDAs definition based on gross
  revenues
• 250,000 and below ? SMALL
• Over 250,000 ? LARGE
• Cost value equity growth rates

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Proxy Variables for Business Growth Strategies

• Asset Management
• asset turnover ratio, tenure ratio
• Capital Management
• debt-to-asset ratio, interest expense ratio
• Revenue Enhancement
• net farm income ratio, net non-farm income
• Cost Reduction
• operating expense ratio, family living expenses

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Variables Small Farms Small Farms Small Farms Large Farms Large Farms Large Farms All Farms
Class 1 Class 2 Class 3 Class 1 Class 2 Class 3 All Farms
Equity Growth Rate () -9.12 4.18 23.50 -7.34 4.63 13.81 7.88
Asset Turnover Ratio 0.2700 0.3511 0.5485 0.3814 0.2723 0.3665 0.3887
Tenure (ratio) 0.2971 0.1457 0.065 0.2008 0.2260 0.0961 0.1562
Debt-to-Asset Ratio 0.4930 0.3338 0.5926 0.6295 0.2867 0.4517 0.4762
Interest Expense Ratio 0.1404 0.0528 0.0591 0.1177 0.0384 0.0625 0.0756
Net Farm Income Ratio 0.1140 0.2456 0.2088 0.1018 0.2484 0.1707 0.1872
Net Off-Farm Income () 10,638 11,784 14,869 15,778 16,800 30,412 16,401
Operating Efficiency Ratio 0.7440 0.6146 0.6799 0.7550 0.5767 0.6997 0.6773
Family Living () 44,445 47,973 43,204 56,933 47,448 50,716 47,120
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Remaining Variables Under Backward Elimination Procedure Remaining Variables Under Backward Elimination Procedure Remaining Variables Under Backward Elimination Procedure Remaining Variables Under Backward Elimination Procedure Remaining Variables Under Backward Elimination Procedure
Variable Small Farms Small Farms Large Farms Large Farms
Coefficient Prob gt /T/ Coefficient Prob gt /T/
Intercept -0.135788 0.1597 -0.188167 0.4732
ATO 0.448029 0.0001
TENURE -0.310690 0.0087
LEVERAGE -0.206282 0.0531
NFIRAT 0.765945 0.0002 0.745097 0.0192
OFFARM 0.000006632 0.0004
OPRAT 0.514291 0.1133
FAMLIV -0.00000425 0.0025 -0.00000189 0.0430
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Summary of Findings

• Interdependence of capital and operating plans
  for growth
• For both small and large farms
• BUT differ in choices of growth strategies due to
  heterogeneity of business conditions

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• OPERATIONS MANAGEMENT
• BOTH farm types Increase farm returns and
  minimize family living withdrawals
• Small Farms Enhance revenues from non-farm
  sources
• Large Farms Effective cost reduction strategies
• CAPITAL MANAGEMENT
• Small Farms Asset Productivity
• Large Farms Debt Management and Leasing
  strategies

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Farm-Level Evidence 2Financial Management
Characteristics of Successful Farm Firms

• MOTIVATIONS
• Financial stress of the 1980s
• 123 farms operating in 1985-1988
• To identify a dominant group of financially
  successful farm firms

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Methodology

• Three Levels of Success
• Successful, Less Successful and Least Successful
• Statistical difference between financial ratios
  for two extreme groups
• Four performance measures
• NFI/AC Net farm income per tillable acre
• MR/AC Management returns per tillable acre
  (NFI less interest on equity capital and unpaid
  family and operator labor)
• NFI/FEQ Net farm income per dollar of farm
  equity
• MR/FEQ Management returns per dollar of farm
  equity

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FINANCIAL CATEGORIES

• LIQUIDITY
• Current Ratio
• Current-Intermediate Ratio
• ASSET MANAGEMENT
• Current to Total Assets Ratio
• Fixed to Total Assets Ratio
• VFP to Total Assets Ratio
• DEBT MANAGEMENT
• Debt-to-Asset Ratio
• Interest Expense Ratio
• Times Interest Earned

• PROFITABILITY
• Rate of Return on Farm Assets
• Rate of Return on Farm Equity
• Net Profit Margin
• OPERATING EFFICIENCY
• Operating Expense Ratio
• Depreciation Expense Ratio

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RESULTS
Ratios NFI/AC NFI/AC MR/AC MR/AC NFI/FEQ NFI/FEQ MR/FEQ MR/FEQ
Ratios Top Bottom Top Bottom Top Bottom Top Bottom
CA/CL 5.55 2.09 2.22 4.93
CA-IA/CL-IL 3.54 3.65
CA/TA 0.24 0.38 0.17 0.34 0.24
FA/TA 0.48 0.22 0.60 0.30 0.46
VFP/TA 0.32 0.21 0.41 0.15 0.36 0.23
D/A 0.24 0.47 0.23 0.41 0.24 0.44
INTRAT 0.06 0.18 0.08
ROE 0.78
NFIRAT 0.39 0.27 0.36 0.40
OPRAT 0.49 0.58 0.50 0.60
DEPRAT 0.17 0.14 0.18 0.13 0.17 0.13 0.18