Tighter markets and a better crop year bode well for farm margins this year, but global competition tempers outlook.

Hopefully, you're ready to hear some good news where net farm income is concerned. It's running ahead of 2002 at this point in the year, and should top last year's net by $12 to $13 billion.

But 2002 provides a low benchmark for comparison. Farm income took a $13-billion dip last year, primarily because of lower livestock prices and reduced government payments. Delayed sign-ups for the new farm program meant that some payments that might have been made in 2002 were carried over to 2003, which contributed to the net income shortfall in 2002.

A $13-billion boost will put net farm income at $47 to $48 billion for 2003--about the average for the past 10 years. While income remained relatively stable (with a few dips and peaks) for the past decade, the percent of net farm income derived from federal farm payments has climbed from about 20 percent to fully half of total net income. At least a third of the projected 2003 increase in net farm income will come from government payments of one kind or another.

"Farm income is expected to continue at about that level [$47 to $48 billion] for most of the next 10 years," said Bob Young, until recently, the co-director of the Food and Agricultural Policy Research Institute (FAPRI) at the University of Missouri. Young this month became chief economist for the American Farm Bureau Federation in Washington, D.C.

"The 2002 farm income drop was due primarily to lower livestock prices, but reduced government payments also played a role," Young added. "We expect prices for cattle and hogs to improve this year, and prices for both beef and pork should continue upward until 2005, when reverses in livestock production cycles will cause price declines."

Prices for major crops--corn, wheat, soybeans and cotton--are running somewhat ahead of 2002, and should be above their 5-year average by 4 percent or more. U.S. corn stocks in all positions were put at 2.98 billion bushels on June 1, down 17 percent from a year earlier. Dry weather the past two seasons also has cut oilseed stocks. However, stiff global competition will limit crop price rallies in 2003.

"Cotton prices are running somewhat higher than we expected earlier, too," said Pat Westhoff, FAPRI economist. "But even with higher prices and above-average yields, net returns to crop producers haven't moved all that much."

Higher crop input prices--especially for natural gas and fertilizers that use natural gas as a feedstock--have boosted production costs for many growers. As a result, farm profits may not be substantially higher, even with better crop and livestock prices.

What does this mean in terms of farm financial health? FAPRI tracks 42 representative Missouri farms from all areas of the state. In March 2003, FAPRI published a 5-year (2003 through 2007) financial baseline for these farms.

"In general, 2002 was not a good year for representative farms," the report said. "Government payments were delayed and were dramatically lower for many farms. A quarter of the farms began the projection period with a negative cash balance. That is, they technically have no cash on hand and maintain a carryover operating loan balance. Another one third of the farms have accumulated less than 25 percent of their annual operating expenses."

The low-income year of 2002 has put more farms at risk, no question. However, despite this recent financial history, the future looks brighter for most farms.

"Perhaps the best summary of financial outlook for the 42 representative farms is to examine the risk scores assigned, based on probabilities of cash flow deficit or declining net worths," the report continued. "Nine of the farms are projected to meet cash needs and build wealth by accumulating cash or other business assets."

Farms in this category tend to be larger in size; many use marketing contracts or other tools to reduce price risk. Interestingly, as a group, dairy farms show the least risk over the 2003 to 2007 period.

"On the other end of the spectrum are high-risk farms," said the report. "Seven (l6 percent of the representative farms) are not expected to be able to continue farming the same way over the next 5 years without severe financial consequences."

For the majority (26 of the 42 representative farms), solvency is not so much an issue, but liquidity may be a major concern. The implication is that there will be one or more years in the 5-year period when these farms will fail to generate enough receipts to meet cash needs.

The 2002 bottom line for Kansas farmers enrolled in the Kansas Farm Management Association (KFMA) records program shows even bigger drops. The 49 percent decline in Kansas net farm income was brought about by severe drought, especially in the western half of the state. But a changeover in farm laws, lack of market-loss assistance payments and farm legislation that is partially tied to production worsened the plummet.

"The value of KFMA members' current assets dropped an average 4.1 percent," said Marty Albright, agricultural economist and KFMA administrator. "The debt-to-asset ratio increased from 0.34 to 0.35. When net farm income does not cover family living costs and taxes, farmers or other family members have to look for off-farm income sources. Otherwise, equity erodes or farmers may need to increase debt. Farms in strong financial position can withstand shortfalls for a while, but protracted low net farm income eventually takes a toll, even on strong farms."

It takes a toll on rural communities, too, noted Nancy Novack, economist with the Kansas City Federal Reserve Bank's Center for the Study of Rural America.

"The level of income in rural areas affects nearly every element of a community," she said. "Higher incomes generate more tax dollars to support schools and build new infrastructure, and also mean more disposable income to spend in Main Street businesses."

While incomes in rural America have climbed steadily, they have persistently lagged those in more urban areas. And the gap is widening. In 1970, farming and farm services accounted for a fifth of rural earning, but this share has dropped steadily, to less than 8 percent today.

What's the outlook for farm profitability in the near-term future? Corn and soybean prices this year are running marginally above levels that would trigger government counter-cyclical payments. Bob Young expects prices for both commodities to trend slowly upward for the rest of the decade, but may never top the 2002-03 season average prices.

"Prices for cotton and rice face about the same prospect," said Pat Westhoff. "Government payments to rice and cotton growers may be lower than last year. And proposed farm program payment limits could hit large cotton and rice farms harder than farms growing corn, soybeans, wheat or sorghum."

So, production agriculture appears to be heading into a period of relative prosperity. But that's relative to a "crunch" year that saw cash flows turn into a dribble; a time when average farm net worths shrank.

And with Congress looking for more ways to trim spending, the federal safety net may drag shallower this year and thereafter.