Nearly a third of Minnesota farmers are losing money, according to a joint report from our two statewide public university systems. This is not surprising news. Most farm product prices are down and everyone in the sector knows that farmers are making less money than a few years ago and that some are in bad straits. Farm equipment isn’t selling as well and farm lenders say they have more problem loans on their books.
But what does it really mean for a farmer to “lose money?” Answering that involves some basic economics that also applies to other situations. So it is useful to review even if you are not affected by farming.
To most people, especially those who work for someone else, ie. most of us, the idea of “income” is pretty straightforward. It is the amount of money listed on your pay slip. It may distinguish between gross pay, before taxes, and after your share of benefit contributions like health insurance are taken out, and the net afterward, but you don’t think about changes in the value of assets. That affects you over the longer run, but isn’t in our minds when we think of “income.”
Value, however, is considered by accountants and economists. Accounting students learn that income is something archaically worded as “consumption plus accretion to net worth.” In other words, income is what you spent satisfying needs and wants plus the net change in the value of what you own and what you owe to others. And that almost certainly is different from the sum on your W-2 or on the tax return you file.
There are some further complications in distinguishing between “consumption” and “change in net worth.” If you buy new shoes, take the family out for burgers, pay for a root canal or gas up the family sedan, these are clearly consumption. A major re-do of the kitchen or buying a new pickup, each in the neighborhood of $40,000, are both long-term purchases and not current consumption. Both involve spending money now but also increase the total value of assets you own.
But what about spending $700 on a new dryer when the old one dies or putting $2,500 into a rebuilt transmission, ball joints and other items so your old sedan will get you to work and back a few more years? Maintenance or investment? Consumption or change in net worth?
Considerations like these are even more complicated for farmers. A dairy farm buys feed, vet supplies, seed, fertilizer and a lot of electricity. These are expenses. It sells milk and perhaps corn or soybeans. This is income. Subtract the expenses from the income and you have a first approximation of “profit” or “net income.”
But what about payments on the farm mortgage or on a machinery loan? How does the interest part of the payment count differently from principal? What about buying a new machine or building? What about the additional 500 hours on the meters of all the tractors or the added wear on all the chains in the silage wagons after another year? What about the 12,000 bushels of soybeans that you harvested but have not sold yet? What about the fact that land prices in your area increased $500 per acre this year or, more realistically, that they fell by a few hundred dollars?
For individuals, the decline in the value of a kitchen range or SUV does not affect their income, either in their own minds or on the forms they’ll send the IRS this month. But such “depreciation” is an expense for businesses. It reduces the income calculated for internal management purposes and reported on tax forms. However, what the rules let you deduct for tax purposes is not exactly the same as the actual decline in market value of the item.
Other assets are even more complicated. Virtually all nonfarm businesses must keep their accounts on an “accrual basis.” So if a contractor has finished a building and submitted an invoice to the owner for the final payment, that account receivable increases income even though the payment check is not yet in. If Cargill has 400 million bushels of wheat in storage and the market price of wheat goes up $1.25 a bushel, then the increase in value of inventories also increases income.
But farmers have special treatment. They still are allowed to use “cash accounting.” The diesel fuel, seed and herbicide used to grow soybeans are costs in the year they are paid for. But the resulting soybeans harvested and put in a bin are not income until they are actually sold and the income is “realized.”
This allows farmers to play games that other businesses cannot. Does it look like your 2016 income will be high? Before New Year’s, pay the co-op for 10,000 gallons of diesel. A nonfarm business would have a cash expense offset by an identical increase in value of inventories. But for the farmer it is just a 2016 expense, period. Does it seem like 2016 was a bad year and 2017 may be more profitable? Ask uncle Joe if you can hold off giving him the fall cash rent payment for the west quarter-section until after the first of the year. That moves an expense from a low-income year to offset taxes on a potentially high-income year.
So far, this is mostly accounting. But there also is the economic question of fixed versus variable costs. Variable costs are those that change with the level of output and are zero when output is zero. Fixed costs are ones that don’t change with output and that you have to pay even when you are not producing anything. The only way to stop them is to liquidate or restructure the business.
For a farm, seed, fertilizer, fuel, repairs, electricity and feed are typical variable costs. The real estate taxes, mortgage interest, fire, wind and liability insurance typify fixed costs.
A reader recently queried whether farmers should be glad to put land into Gov. Mark Dayton’s proposed riparian filter strips since they reportedly are losing money growing corn anyway. The answer is that the income from raising corn still is higher than the variable costs of doing so. But that surplus is not enough to cover the farm payment and taxes. Voluntarily putting the land into a conservation use and you still have to pay those fixed costs. Much better to keep on growing corn and have some surplus above variable outlays so that you can pay at least some of the fixed costs than to have no income at all and have to pay the same amounts out of your net worth.
Yet another complication is that for some operators, fixed costs require an actual outlay of cash. For others, some are only an “opportunity cost,” the value of something given up.
Farmers Woody and Cindy are in their 60s and their land is paid for, as is their serviceable machinery. After they sell their corn and beans, pay for all the consumable inputs used and land taxes, there is enough money left over to live quite nicely. But any return on the $5 million or so tied up in their land is miniscule. And if they want to go to their grandkid’s destination wedding in Punta Cana, they have to pull money out of their IRA. Their kids and economists may tell them they should sell out and put the money in Fidelity, but they are never going to be foreclosed on.
Farmers Mark and Elena are about 40 and bought nearly all their land in the last decade. They pay $400,000 in interest alone on their mortgage. And they still owe over $1 million on tractor, combine, high tech sprayer and other machinery. After they sell their crop and pay for the same variable inputs, there isn’t nearly enough left to service their debt. Their loan officers are already using terms like “liquidation” and “workout.” Unless prices improve soon, they will be bankrupt.
Both couples are good farmers and good money managers. But they got into the business at different times in cycles of product prices and land values. An economist would say that both are earning very comparable “economic profits” from farming. But to the couples themselves and most other people, the older duo is earning a little profit and the younger one is experiencing a big loss.
The upshot is that it is hard for non-farmers to understand exactly what it meant when one reads about farmers losing or making money. An average net income listed is not the same as that amount for an urban employee. But year-to-year changes tell us something. So do land prices. If your farmer cousin complains about how tough farming is but land prices in his area are rising, then farmers are making good money and anticipate things will continue rosy. If they fall, the reverse is true. I’m pleased that the report was as positive as it is, but don’t expect that to be true in the future.