A third of farmers in my home state of Minnesota are losing money, according to a university report. This is probably true elsewhere and is no surprise. Product prices are down. Equipment isn’t selling well. Lenders have more problem loans.
But what does it really mean for a farmer to “lose money?”
To most people, “income” is straightforward: It is the amount on your pay slip. People may distinguish between before- and after-tax amounts, but most people ignore changes in the value of assets.
Net worth, however, is considered by accountants and economists. Accounting students may learn that income is “consumption plus accretion to net worth.” In other words, income is what you spent for needs and wants plus the net change in the value of debts and assets. Almost certainly that differs from your W-2 or tax return.
There are 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 car, these are clearly consumption. A major re-do of the kitchen or buying a new pickup, each about $40,000, are both long-term purchases and not current consumption. Both involve spending money now, but they increase the total value of assets you own.
What about spending $700 on a new dryer when the old one dies or putting $2,500 into a rebuilt transmission, ball joints and the rest so your old car will run a couple 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 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 wheat are costs in the year they are paid for. The resulting wheat 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? Pay for supplies for next year by Dec. 31. Income low? Don’t pay some bills until after Jan. 1 or arrange to make the fall rent payment for this year that same month.
This is accounting. There also is the economics of fixed versus variable costs.
Variable costs are those that change with the level of output. They 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. Real estate taxes; mortgage interest; and fire, wind and liability insurance are typical fixed costs.
A reader queried whether farmers should put land into proposed riparian strips since they lose money growing crops. No! Income from crops remains higher than variable costs of production. But that surplus doesn’t also cover the farm payment and taxes. Stop cropping and you still must pay such fixed costs.
Better to continue growing corn and have some surplus above variable outlays than to have no income at all and have to pay fixed costs out of pocket.
St. Paul economist and writer Edward Lotterman can be reached at email@example.com.