By: Dr. David Kohl
The economic reset encompassing agriculture and rural America bares both financial and behavioral implications for producers. In my travels, I see some producers in a perpetual state of denial. Others procrastinate hoping for weather adversity to rebound commodity prices. Whatever the case, there appears to be a widening gap of farm profitability regardless of the enterprise. In order to understand this trend, we need to examine farm data. The 2015 FINBIN data from the University of Minnesota’s Center for Financial Farm Management is an excellent resource. This data summarizes performance from over 8000 farms from multiple states. Additionally, this database represents above average producers who maintain good records. Of course, in these economic times, above average practices are required for success.
Overall Difference Makers
Examining median net farm income, the top 20 percent of farms generated $184,483. This is a stark contrast to all farms, whose median profits were $27,217. The low 20 percent of farms recorded a median profit of negative $73,321. That calculates to more than one-quarter of $1 million difference in profits between the top and the bottom 20 percent of farms. Clearly, an astounding difference!
Of course, this raises the question of what the top 20 percent of farms are doing as compared to the rest of the spectrum. Well, the difference can be summarized in two words: proactive management. In this case, proactive management is in the form of cost adjustments and most noticeably, in the cash rent category. The cash rents of the high profit group were $63 less per acre than the low income farms. Others areas of cost adjustment included fertilizer, crop drying, and fuel costs. Cumulatively, these reductions ranged from $20-$50 per acre. In the top 20 percent, farms generated an average profit of $139 per acre in 2015. The average profit for the lower 20 percent was negative $163 per acre. This makes the bottom line difference over $300 per acre which is significant for any operation.
In the livestock industry, there are similar situations and observations. Those farms exhibiting top profitability are focused on feed, labor and repair cost controls. Some of these producers have diversified as a mechanism to complement their other enterprises. Two classic examples are the use of manure to reduce fertilizer costs for crop operations and feeding lower cost grain to economically increase benefit for the livestock enterprises.
Financial Performance
Turning to some of the key financial ratios, the disparity becomes much more apparent. The term debt and lease coverage ratio was over 170 percent for the top 20 percent of farms while the low 20 percent was at 38 percent. This gap demonstrates an insufficiency in earnings to cover debt service payments. Often, this results in the need to refinance losses to term debt. Refinancing is a short-term option; however, producers must map out a corrective plan for long-term sustainability.
Another striking difference appears in working capital, the financial shock absorber. The working capital to gross revenue ratio was above 50 percent for the more profitable farms. Lower-level farms averaged only 1 percent working capital. This creates a difficult situation, especially if the economic downturn continues.
In one of my recent sessions, one lender stated that his customers were “burning through working capital like rocket fuel.” As a result of 2015 economics, the lower 20 percent of farms averaged approximately $270,000 less in working capital when compared with the rest of the FINBIN farms. In contrast, the top 20 percent preserved much of their working capital.
Often, producers ask about the impact of different debt levels. Well, according to FINBIN, the lower 20 percent of farms exhibited a debt to asset ratio that was 17 percent higher than their counterparts at the other end of the spectrum. However, low interest rates are the differentiators on financial leverage in this era with less of an impact as compared to previous time periods.
Although FINBIN includes data from farms in several states, these results are similar to those found in other state record databases as well. As the duration of the reset continues, the gap of profitability will continue to widen. As demonstrated by the top performers, invest in productive assets and maintain close control on fixed and variable costs. In addition, it is critical to build and maintain working capital throughout the economic cycle. Finally, the most profitable farms and producers focus on modest family living costs. These economic times require a strategized, sound business plan that is both executed and monitored. Often, top performers conduct these three critical elements of strategy, execution and monitoring with a team of advisors.
As the economic reset continues, remember to not only monitor finances but address the emotional and behavioral component as well. Examining peer data, utilizing resources and implementing an updated plan will help avoid emotional decisions and missteps on your road to sustainable profit and success. Remember that above average results require above average management and practices.
