During 2005 and 2006, the portion of gross farm revenue needed to pay interest costs has increased.

The median of this financial efficiency measure, interest expense as a percent of gross revenue, was 6 percent in 2005 and 7.2 percent in 2006 for more than 500 farms enrolled in the North Dakota Farm Business Management Education program.

""The past two years have disrupted what has been a very positive trend for farmers,"" says Andrew Swenson, North Dakota State University Extension Service farm management specialist. ""The amount of gross revenue necessary to cover interest costs had declined every year, from 9.9 percent in 1997 to 5.6 percent in 2003. It remained at 5.6 percent in 2004 before reversing course and increasing the past two years.""

To better understand the impact on the bottom line, a farm with gross revenues of $300,000 required 5.6 percent, or $16,800, of those revenues to cover interest costs in 2003 and 2004. Last year it took 7.2 percent, or $21,600. This additional $4,800 of costs causes an equivalent reduction in net farm income.

There are a few reasons for the improvement of interest expenses relative to gross revenue during the 1997 to 2004 period. First, average gross revenues increased from $223,400 to $345,700. By itself, this would improve the ratio of interest expense to gross revenue.

Secondly, interest rates were declining. The combination of higher gross revenues and lower interest rates offset the impact of greater debt as farms increased both assets and debt during that time period. During the past two years, higher interest rates combined with greater debt, have caused the trend to reverse.

Median interest expense as a percent of gross revenue has been correlated with farm type and gross sales.

""Part of the reason is that crop farms and farms with greater sales tend to have lower debt-to-asset ratios than North Dakota livestock farms and farms with fewer sales,"" Swenson says. ""For example, farms with sales of less than $100,000 were more than twice as likely to have a debt-to-asset ratio of more than 70 percent than were farms with sales of more than $500,000.""

From 2002 through 2006, the median interest expense as a percent of gross revenue for crop, mixed crop-livestock and livestock farms averaged 5.2 percent, 8.1 percent and 9.2 percent, respectively. For farms with sales of $500,000 or more, $250,000 to $499,999, 100,000 to $249,999 and less than $100,000, the averages were 3.9 percent, 5.3 percent, 6.7 percent and 9.2 percent, respectively.

""Clearly, farms with greater sales required a smaller portion of their gross revenue to cover interest costs,"" Swenson says. ""Part of the reason is that these farms tend to have better solvency and may be able to get more favorable interest rates."

Interest as a percent of gross revenue is a figure that lenders often consider when determining borrowers' credit risk. At some level, it is a red flag that indicates interest expense is becoming too great of a burden when considering the farm’s capacity to generate revenue.

""Producers should always project, when taking on debt, both the additional costs and revenues associated with the debt capital,"" Swenson says.

NDSU Agriculture Communication