Sobering On-Farm Financials (i.e. Why Transition Finance is Critical)
"Off-Farm Income a Major Component of Total Income for Most Farm Households in 2019." USDA Economic Research Service, Sept, 2021
As promising as soil health is, adoption is limited in the U.S.
Despite the long-term economic and operational benefits, only ~5% of U.S. farmland – approximately 50 million of 900 million arable acres – are in transition as of the end of 2023.
One of the main factors is short-term economic risks.
This tension between long-term benefits and short-term risks is illustrated powerfully in a multi-year study of farms in Minnesota [1]:
The report demonstrates that most participating farmers had higher environmental and financial benefits than regional benchmarks. Overall soil health was improved through increased soil carbon and decreased soil erosion...
Despite the overall positive results, the data indicates there may be increased short-term risks for farmers who recently adopted conservation practices because it can take time to build the health of the soil and there are upfront costs with changing practices.
And a study on the economics of regenerative farming applied to Kansas wheat farms reached similar conclusions [2]:
We found that there can be a positive long-term business case for farmers to transition to more sustainable practices – resulting in a 15-25% 10-year ROI – but that there is likely a transition period of 3-5 years or more where the farmer will experience a decline in profits, due to the risk of lower-than-expected yields.
To put these short-term risks in context, it’s important to understand the fine economic edge that U.S. farmers walk:
Cash flow management: Agriculture is inherently a cyclical business with delayed cash flows. Expenses are incurred throughout the year, while income is typically concentrated post-harvest. This mismatch creates cash flow challenges, requiring either securing short-term operating loans or using the cash generated from the prior year’s crop to pay for the current year’s operating expenses.
Debt service pressure: Loans, in particular mortgages and equipment loans, commit farmers to maintain specific levels of cash flow in order to service debt for many years into the future. Adding pressure, interest expenses are the fastest growing farm production expense (increasing 33.2 percent in 2022 and 19.1 percent in 2023 [3]). To make payments accessible to growers, lenders are increasing payback periods [4] which will create even more stress on producers to maintain or increase revenue levels.
Volatility: The vast majority of farmers sell their crops into commodity markets using chemical inputs derived from fossil fuels. They’re subject on both income and expense sides to market forces that they can’t anticipate or control. This is currently tightly squeezing margins: in 2023, farm incomes dropped 23% year-over-year, and another drop is expected in 2024 with continued higher production expenses (esp. fossil-fuel-derived inputs) and lower commodity prices. [5]
Limited profitability: Average net farm income in 2023 is projected to be $99,300 [6]. However, this obscures a critical factor: it includes both on-farm and off-farm income. 96 percent of farm households have off-farm income, with on average 82 percent of total farm income coming from off-farm sources. When removing off-farm income, 48% of all farms have negative net income, with even 15% of large (> $1m) and 9.3% of very large (>$5m) farms operating in the red. [7]
All told, farms have very little margin of error economically.
It’s easy to see why many growers are very reluctant to change practices without a short-term economic safety net or the promise of immediate financial returns.
Transition finance programs are critical to de-risk this transition for growers.
[1] Profits Through Conservation: Results from 2022 Return on Investment Study, The Headwaters Agriculture Sustainability Partnership (HASP).
[2] Cultivating Farmer Prosperity: Investing in Regenerative Agriculture, BCG, OP2B, WBCSD
[3] Increases in U.S. Farm Debt and Interest Expenses Minimally Affect Sector’s Financial Position in the Short-Term, as Measured by Liquidity and Solvency Ratios, USDA Economic Research Service, Aug 2023
[4] Longer Debt Repayments and Higher Interest Expenses, Agricultural Economic Insights, Aug 2023
[5] USDA Forecasts Sharpest Decline in U.S. Farm Income in History, U.S. Senate Committee on Agriculture, Nutrition and Forestry
[6] Farm Sector Income & Finances: Farm Business Income, USDA Economic Research Service. November, 2023.
[7] Off-Farm Income a Major Component of Total Income for Most Farm Households in 2019. USDA Economic Research Service, Sept, 2021