Are you losing money? That’s a fair question, and many farmers simply don’t know the answer.
The relatively quick downturn in grain prices the past 24 months has made it hard for some operations to keep enough liquidity in their financial tank.
“The downturn has been so steep, it’s been hard to make quick adjustments,” says Vince Bailey, vice president credit – agribusiness at Farm Credit Mid-America, headquartered in Louisville, KY. “You only have one chance each year to adjust costs, and because markets fell so quickly, it’s been too fast to not lose some money.”
Lower input costs should help 2016 crop budgets. But without a weather problem somewhere in the next eight weeks, hopes for higher revenue could remain elusive this fall after harvest. That uncertain outlook should have you looking at not only liquidity for the long haul, but future borrowing capacity. An honest balance sheet and shrinking net worth will make it more difficult to access capital for 2017.
Do you know how to find the numbers that make up your business, and how to use them to determine where your business is going financially? It’s the kind of information that lenders will be demanding more and more, so get ready.
“When you look at the broad picture there are varying degrees of financial stability right now,” says Bailey. “More producers are recognizing where they are financially. In 2015 you either made a little money or lost quite a bit. It was not uncommon to see producers lose upwards of $200 an acre in 2015.”
Unfortunately some farmers aren’t aware they are losing money. Why? It comes back to lender relationships and making financial information easy to understand.
“There are 21 commonly used or standard farm financial ratios used to analyze farm operations,” says Bailey. “While they are all helpful, that is too many for a producer to keep track of on a regular basis. Simplify that by talking with your accountant and lender and find three to five core ratios that have the most impact, and can be easily calculated and tracked.
“When it comes to ratios, trends tell a great story,” he adds. “The remaining ratios may provide insight to ‘why’ if one or more of your core ratios get out of line.”
Fixed cost conundrum
Most farmers understand variable costs because they price inputs and compare those figures to value of farm production. But it’s the fixed costs, like family living, labor, machinery and land, that add to losses and deplete working capital. It’s these cost areas you must focus on now to stay in business for the long haul.
One way to become more aware of your financial situation is to develop a simple, condensed balance sheet – a snapshot of your business. Many figures in this snapshot will come from other parts of your complete balance sheet. You can use the condensed version to make some quick assessments of your business performance.
For example, take a look at how much your equipment costs as a percent of gross revenue. That figure should be no more than 10% for most operations. In Purdue University’s 2016 machinery cost guide, the university suggests that figure will be around $115 - $122 per acre. If gross revenue for corn in 2016 is around $775, that $115 equipment cost represents 13 to 14% of gross revenue, historically too high. Can you find ways to adjust it lower?
Getting family living and labor costs back in line is tough, but there are different approaches you can take. Land grant university studies show grain farms with $500,000 to $1 million gross farm revenue require one full time equivalent employee. In a period of low grain prices, should you – can you – go without a full-time employee? Can you determine how gross revenue will suffer without that employee? Are there labor alternatives you can look to until the grain market recovers?
These are real and difficult decisions you must make if corn prices hover at $3.50 per bushel or lower for the foreseeable future.
Working backwards for profit
One way to shoot for a fix in your balance sheet is to think about your margin goals and work backwards. Let’s say you want a 10% profit margin in 2017. You make a rough estimate of gross income per acre, then work on how to allocate expenses to equal 90% of gross revenues. Think about gross value as all the cash you have to spend to make that crop.
If you take an even bigger picture approach, look at ways you can raise gross revenue – including taking an off-farm job. That may or may not be an opportunity for your family business, but it could change your balance sheet significantly.
If you’re unsure about your financial situation, talk to a lender or your accountant. Get your balance sheet up to speed and create a condensed earning statement so you know where you stand. Talk with those experts about burn rate – how much working capital you may be losing, and work backwards to determine ways to plug the financial leaks by focusing on fixed costs.
With this information in hand, make an appointment with your lender to talk about the three things that drive your business right now: liquidity, burn rate and equity. Nail down the core ratios that mean the most to your business.
You’ll sleep better.