November 8, 2001 | By: Aimee D. Heald
LEXINGTON, KY.

Wise farm families set personal and business goals for their family and their enterprises. Many times one of those goals is to get out of debt.

University of Kentucky Farm Management Specialist, Steve Isaacs said debt reduction is a SMART goal – Specific, Measurable, Attainable, Relevant and Timed.

“The most obvious way to measure this goal is by the amount of money the family owes to a lender,” he said. “If the balance is going down, progress is being made toward reaching the goal.”

Isaacs said another way to measure progress is by monitoring changes in the debt/asset ratio on the farmer’s balance sheet. The debt/asset ratio is the amount of money owed to someone else, divided by the amount of total assets in the business. It is the percent of the business owned by creditors.

“Another way of looking at the debt/asset ratio is by realizing there are two kinds of capital in a farm business – yours and someone else’s,” Isaacs said. “Equity is the part of the business you own, and debt is the part of the business someone else owns.”

Another factor in debt is the equity/asset ratio. Isaacs said this is the part of the business the producer owns.

“Obviously if these ratios are added, the sum will always be 100 percent,” he said. “If the debt/asset ratio is 25 percent, then the equity/asset ratio will be 75 percent. You own 75 percent of the business, the lender owns the other 25 percent.”

When the debt/asset ratio is zero, the family is out of debt.

Isaacs said monitoring the debt/asset ratio over time is an excellent way to determine progress toward a goal of being debt free, as well as a good reason for completing an annual balance sheet.

“While eliminating debt may be the stated goal for the long run, lowering the relative amount of debt may be a good short-run goal,” Isaacs continued. “Some may be asking what is a good debt/asset ratio? Generally, farm management advisors and lenders like to see the debt ratios below 50 percent.”

At ratios higher than 50 percent, the lender owns more of the business than the farm family. Isaacs said that might be a legitimate situation for beginning farmers who have acquired a lot of debt for land and other capital items. But he recommends beginning farmers getting below the 50 percent debt ratio mark as soon as they can.

“Completing an annual balance sheet on your own, with the help of your lender, accountant, or farm management advisor makes good farm management sense,” Isaacs said. “It will help farmers keep track of their progress as they work toward reducing debt.”

Contact: 

Steve Isaacs 859-257-7255