Farm liquidity and business risk from the risk balancing perspective: evidence from selected U.S. states

Abstract We develop a model integrating liquidity and risk management within the classical risk balancing framework, incorporating the current ratio as a measure of liquidity reserves within the Dupont Identity. Two hypotheses are proposed: (1) The current ratio increases with higher business risk, reflecting precautionary behavior, and (2) The current ratio decreases with higher expected return to assets, reducing liquidity reserves. Using state-level data (1995-2019) from nine US states, we find that business risk is positively associated with liquidity reserves, as higher business risk leads farmers to hold greater liquidity reserves. We also find that the choice of the income measure influences both the magnitude and significance of the relationship between current ratio and business risk. Our findings provide insights for policymakers aiming to align risk management tools with farmers’ financial behavior.