In some instances, farms are not operating at efficient levels and are simply losing money regularly until eventually the accumulated losses take the operation away. In other cases, opertions may be efficiently operating, but unable to withstand any major shocks. Even a good farm, if it suffers major crop losses without crop insurance can quickly become financially troubled. There are numerous other reasons as well, including personal injuries, lawsuits, etc. that can cost enough money to take the assets of the farm. Solvency is defined as the ability of a farm to meet all of its financial obligations and may be measured by several ratios, including total debts divided by total assets.
Financial management is the key to managing solvency.
Prudent cost controls and borrowing practices, paying down debt, etc. It is important to note the role of leverage in this case. Leverage can be defined as the ratio of borrowed capital divided by owned capital invested in the operation. As one becomes more highly leveraged, they face greater financial risk, both from increases in interest rates as well as from losses that could impact the farm's ability to repay debt. However, even with its inherent financial risks, borrowing capital can be a wise management decision.