Each month in Wallaces Farmer magazine, the Timely Tips panel answers questions sent by readers. Members of the Timely Tips panel are Alejandro Plastina and Wendong Zhang, Extension economists, Iowa State University; Leslie Miller, Iowa State Savings Bank, Knoxville; and Rob Stout, Master Farmer, Washington, Iowa.
My full-time employee is asking for a raise. It’s been two years since I gave him one, and he’s worked for me for four years. He’s a good employee. We don’t give end-of-year bonuses, and we’re likely going to just break even this year in our farming operation. Should I go ahead and give him the raise?
Stout: Unfortunately, the past four years have been a time of decreasing commodity prices and profitability, and many farms are in a loss position. Others are in the same situation and haven’t been able to give raises. I haven’t been able to give myself a raise for four years, either. Hopefully, your employee understands the situation. I suggest having a talk with him and explaining your desire to keep him in your employment with the hope of increased wages at a later date. If the trade situation with China gets resolved, it is possible prices would rise enough so you could offer a midyear raise. Are you doing all you can to provide other perks, such as use of a farm vehicle, meat from your livestock operation, if you have one, or adequate vacation time? Ask the employee if there is anything else you can do to help keep him happy until you can increase the money.
Zhang: It’s critical to recruit and retain good employees to make your operation successful. Given you know he is a good employee and you haven’t given him a raise in two years, I would give him the raise. In addition to the bump in pay amid holiday season, it is also important to show appreciation for him and other employees: do weekly or even daily check-ins with each of your employees so their issues or concerns are promptly addressed, invite the employees for dinner parties, and let him and all employees know you care about them and their families and are willing to offer raises and other considerations even during the currently tough financial environment.
Miller: It’s not unusual for someone to expect an annual raise. They’ve gained a year of experience in the job and want to be compensated for that extra knowledge and skill level. That expectation comes whether the farm operation is making money or not. After all, they are not a partner in your business, they are an employee. If you are already at a pay level where you can hire new help and not lose the skills you need, then you can choose to keep the pay level the same and face the risk of losing the employee. If the employee is underpaid, then the only reason your operation is breaking even is because you underpay your labor.
Ratios reveal potential trouble
I’m concerned about our farm’s budget for 2018. My operating note is higher than projected. Is there some type of ratio between the size of the operating note and gross income sales or net income that will tell me if I’m in trouble?
Stout: There are several ratios to look at that can give you an indication of your operation’s financial health. However, I’m unaware of a standard ratio comparing operating note to gross or net income. I think it would vary a lot depending on the type of operation you have. For instance, a farmer who owns all of his or her land would be vastly different than one who cash-rents all of the land. One who buys feeder cattle or pigs to feed out will vary a lot from one who owns a cow herd and sells calves at weaning. It’s good to be concerned. Get your financial records together, so when you meet with lenders, they can get a good snapshot of your situation. Being upfront with your lender about your concern is a good first step to heading off any potential trouble, because you can make changes, if need be, to improve your financial situation. The ISU Ag Decision Maker website has financial analysis tools you can use to evaluate your financial picture.
Plastina: Interest rates for ag operating loans increased by 0.82 percentage points between third-quarter 2016 and second-quarter 2018, as reported by the Kansas City Fed. In dollar terms, the annual interest expense for every $100,000 in operating loans was $820 higher in late June 2018 than in late September 2016. Furthermore, USDA has recently forecast a 13% decline in average national net cash farm income in 2018. Thus, it isn’t surprising to see operating notes take up a larger share of farm income in 2018.
One financial ratio serving as a benchmark for interest expenses is the “interest-expense ratio,” calculated as total farm interest expenses (including operating, machinery and land loans) divided by gross farm income. The Farm Financial Standards Committee suggests that a ratio below 5% indicates strong financial efficiency, and a ratio above 10% is indicative of weak financial efficiency (between 5% and 10% should be “under watch”).
In Iowa, midsize commercial farms had an average interest-expense ratio of 3% over the last 10 years (2008-17). However, the ratio reached its lower level in 2011 at 2% and increased to 4% in 2016 and 2017. Each year, the ratio also varies across groups of farms.
For example, in 2017, midsize commercial farms with value of gross sales above $800,000 spent, on average, $68,000 in interest expenses, resulting in a 3% interest-expense ratio. Also, in 2017, midsize commercial farms with values of gross sales between $100,000 and $199,999 spent, on average, $15,121 in interest expenses, and showed a ratio of 5%.
Using financial information from 3,367 farms across eleven states, the University of Minnesota FINBIN reports the median interest-expense ratio in 2017 at 4.4%. However, 20% of the farms in that sample had a ratio of at least 11.1%.
For detailed information to benchmark farm financial ratios against midsize commercial farms, Ag Decision Maker's Iowa Farm Costs and Returns.
Miller: I could write an entire page about the concept of “some sort of ratio.” In the very first meeting of the task force that designed the Farm Financial Standards, all the experts weighed in with comments along the lines of “an acceptable value for each measure may vary depending on the type of operation, value of assets, time of year, length of tenure, etc.” That’s why, when you read the publication on the Farm Financial Guidelines, you notice there are limitations described for each measure.
For your farming operation, your operating line is too high if that note plus unpaid rent or inputs, term payments (on land, machinery and breeding livestock), taxes and living expenses cannot be paid back with the income you expect from your annual production of crops and livestock. It’s also a good idea to have some money left over from those sales to cover the cost of physical depreciation and replacement, and some profit (or return) for your investment in the business. However, that may be hard given today’s crop prices.
If the revenues you expect can’t cover those costs, then it’s time to sit down with your lender and see if some short-term debt can be restructured, or you can get by for the year with just paying interest on your term payments.