Economic health and viability are at the forefront for many involved in today’s agriculture industry. While some may prefer to just eat ice cream and hope for improved opportunities, proactive management strategies will be required for success.
The first strategy is to create and maintain an accurate, complete set of financial records. Knowing the numbers allows for informed, strategic decision-making in day-to-day operations as well as for overall business evaluations. It is critical to know the cost of production and breakeven levels in all scenarios, given differences in price, costs and production. Implementing this strategy will help mitigate risk and make economic viability much more obtainable.
If you are borrowing money, it is critical to monitor two financial ratios: coverage and operating expense to revenue. First, coverage ratio is one to watch closely. Simply put, the coverage ratio is net income (farm and non-farm) before interest and depreciation, minus living withdrawals and taxes, divided by your debt service payments. For example, if a farm has $200,000 in net income and $80,000 in family living withdrawals, the debt servicing ability would be $120,000. If debt service obligations are $80,000 annually, the ratio would be 150%. Strive to maintain a coverage ratio above 125%. This ratio level provides protection against major risks and other unexpected circumstances along the road to success.
The second financial ratio to watch is the operating expense to revenue ratio, which is the cost of generating one dollar’s worth of revenue excluding interest and depreciation. In the aforementioned example, net income was $200,000. Assume the revenue was $800,000 and operating expenses were $600,000. Here, the operating expense to revenue ratio would be 75% ($600,000/$800,000). Historically, careful financial management suggests maintaining a ratio of no more than 75%.
This type of proactive, detailed management should not be done alone. Utilize a good team of advisors including your lender, farm management consultant and production advisors to generate solutions. Outside expertise can be invaluable in determining the best course of action. In some cases, farm decisions can be emotional and complicated. Farm advisors can often offer an outside, unbiased perspective, which brings clarity as well as comfort. Continued, incremental improvement is always important, especially during hard economic times. Reach out and utilize available resources not only to survive, but to continually improve your ability to succeed in every economic environment.