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Using Solvency Ratios to Predict Future Profitability

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  • Ibendahl, Gregory

Abstract

Solvency ratios are normally used as an indicator of the long-term viability of the farm business. Farms with high leverage have a greater likelihood of going bankrupt. Bankruptcy occurs because a farm loses its equity. However, for a farm to lose equity, it must generate negative profits or family living withdrawals must exceed profits and any equity increases. In either case, low profitability is likely a major factor in a farm losing equity. This might imply that highly leveraged farms, which pay more in interest expense, are earning less profit than those farms without debt. Thus it might be possible to predict future profitability based on solvency ratios. This paper tests that hypothesis but finds a naïve model of looking at past profit to predict future profits works better than using solvency ratios.

Suggested Citation

  • Ibendahl, Gregory, 2016. "Using Solvency Ratios to Predict Future Profitability," Journal of the ASFMRA, American Society of Farm Managers and Rural Appraisers, vol. 2015, pages 1-7.
    • Handle: RePEc:ags:jasfmr:236666
    DOI: 10.22004/ag.econ.236666
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    References listed on IDEAS

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    1. Li, Xin & Paulson, Nicholas, 2014. "Is Farm Management Skill Persistent?," 2014 Annual Meeting, July 27-29, 2014, Minneapolis, Minnesota 170170, Agricultural and Applied Economics Association.
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    Agricultural and Food Policy;

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