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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.