Establishing Farm Debt Reduction Goals
When farm families get around to writing down some personal and business goals, one of the most common goals is, "to be out of debt." This fits the criteria of being a SMART goal. These criteria state that a goal should be Specific, Measurable, Attainable, Relevant, and Timed. Being debt free by a specified date meets these standards for most farm families.
The most obvious way to measure this goal is by the amount of money owed to a lender. If the principal balance is going down, then progress is being made toward reaching the goal. Another way to measure progress toward this goal is to monitor annual changes in the Debt/Asset ratio on the balance sheet. The D/A ratio is simply the amount of money owed to someone else, divided by, the amount of the total assets in the business. It is the percent of the business owned by your creditors.
Another way of looking at the D/A ratio is this. There are two kinds of capital in a farm business... yours and someone else's. Equity is the part of the business you own, and debt is the part of the business someone else owns. D/A ratio represents the percentage of the business owned by some one else.
The other side of the coin the Equity/Asset ratio. This is the part of the business you own. Obviously, if these ratios are added, the sum will always be 100%. If D/A ratio is 25%, then E/A ratio is 75%. You own 75% of the business the lender owns the other 25%.
Now, back to measuring progress toward getting out of debt. That goal will be reached when the D/A ratio is zero. The E/A ratio then will be 100. Monitoring the D/A ratio over time is an excellent way to determine progress toward this goal, and is a good reason to complete an annual balance sheet. With an annual balance sheet the debt and equity ratios can be calculated and plotted over time.
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. This entire discussion begs the question of, "what is a good D/A ratio?". Generally, farm management advisors and lenders like to see debt ratios below 50%. At ratios above 50%, the lender owns more of the business than the owners. While this may be the case for beginning farmers who have acquired a lot of debt for land and other capital items, getting debt below 50% of total assets should be major objective for farm businesses.
Completing an annual balance sheet.. on your own, with the help of your lender, accountant, or farm management advisor makes good farm management sense and will help track progress toward debt reduction goals.