Farm Progress

Deep Dive management: Think big in managing margins

It could keep your farm in the black this year.

Larry Stalcup

February 7, 2018

7 Min Read
“You need to know what you’re spending and what you can make,” says Jack Scoville, analyst for Price Futures Group. “Most farmers have a good idea on both, but with tight margins, they need to have a detailed budget to follow.”

With corn and soybean margins stuck in a rut, margin management becomes as critical as harvesting high yields. But by mimicking systems employed by corporations facing similar scenarios on a larger scale, farmers may squeeze out profits that could have been lost.

The Cargills, ADMs and GMs of the world have entire teams devoted to integrated margin management. Realistically, even the largest farms may have only one or two with expertise in margin management.

But even if you’re the one pushing the broom one minute and pulling the trigger on input buys or grain sales the next, there’s a lot riding on better margin management.

Bruce Sherrick, University of Illinois ag economist, says improved production efficiency depends on good input management coupled with crop sales. “While larger companies have specific teams and accounting systems to measure margins, individual farmers are not likely to have the option to employ a dedicated cost accounting resource,” he says. “However, better and more complete cost records are part of every operation’s effort to improve efficiency.”

First up: crop budgets

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First, a detailed crop production budget is a must, one that covers every likely expense and crop price potential. Sample 2018 budgets developed by the University of Illinois’ Farmdoc program and other Corn Belt universities show some profit potential for corn and soybean production. It varies from region to region. Penciling out your budget can show how a bad buy on one or more inputs coupled with a decrease in grain prices can put returns in the red.

For central Illinois' high productive land (see chart), Farmdoc projects a corn-after-soybean profit of $242 per acre based on a $3.80 a bushel if you own the land. If land is rented at $150 per acre, profit potential drops to about $90 per acre. But with volatility always a threat, projected profits could change in one or two limit-down moves in corn futures.

The same threat occurs if fertilizer prices or other high inputs jump before you get them locked in. Risk management in both input purchases and crop prices are equally important in margin management. Millennial growers, those born in the late ’70s through the early ’90s, are grasping this management theme, says Jack Scoville, an analyst for Price Futures Group in Chicago.

“More younger farmers are using detailed crop production budgets,” he says. “You need to know what you’re spending and what you can make. Most farmers have a good idea on both, but with tight margins, they need to have a detailed budget to follow.”

Like Sherrick, he doesn’t see farmers hiring one consultant to manage inputs and another to handle pricing. “If it fits into your budget, consider it, but you’re likely looking at a lot of expense,” Scoville says. “Still, farmers should take extra time to find the best deals for fertilizer and other inputs; then determine a profitable crop.”

Farm management software 

Better farm management software evolves with every advancement in computer tech. These systems can aid in margin management.

“Farmers should be able to identify their risks up and down,” Scoville says. “Good software programs are out there and should be considered. But a lot of farmers don’t want to spend the money or don’t use them properly. I don’t know that they’re necessary, just as long as you know your costs and know at what level you’ll be profitable. The software may not be necessary, but it can help organize your thoughts. It also forces you to follow through on your program.”

Sherrick agrees that farm management software may not be necessary but will likely help growers.

“There have been some incredible advances in activity logging and peer reporting software systems,” Sherrick says, noting that many equipment manufacturers offer management software packages. “Machine data integration with the financial impact of production is a focus of many companies’ efforts to develop farm management software.”

Know your KPI 

Many companies count on “key performance indicators” to gauge product and service performance. KPIs could also benefit farmers, Sherrick says. “Listing, then measuring KPIs can help farmers manage their margin,” he says, noting that KPIs will likely fluctuate from farm to farm and even field to field, depending on soil and other conditions. “From year to year, KPIs may vary a bit, so having a good system to index your performance against past years is also key.”

Scoville says the tighter the margins, the greater the advantage of identifying KPIs. “A margin management plan should include those,” he says. “If you think you’re only going to make $5 per acre, you better know what your costs are and what you can sell for. You have to be able to know the metrics, and KPIs can enhance that capability.”

Depending on action taken by the grower, price risk protection should be a component in determining market prices and ultimately a profitable margin, Scoville says.

“The use of futures and options is still absent among many farmers, but that doesn’t mean they don’t use price protection,” he says. “Most farmers aren’t doing much hedging, but they are still trying to get some sales on the books.

“I find that younger farmers who’ve had some marketing training in school tend to do more hedging,” he adds. “They may even have the expertise to analyze inputs costs vs. projected sales. But no matter what, with the costs involved in growing corn and soybeans, some sort of price protection is needed.”

There are often questions on whether to, or when to, lock in inputs or grain sales.

“You need to look at both sides,” Scoville says. “Rather than lock them in, identify what your inputs are and what you can market grain for. I have one farmer-client who knows exactly what his inputs are. With that, he identifies a price to sell at. He doesn’t have to worry about storage costs.

“All situations are different. If input costs are known, farmers can uses futures, options or forward contracts to manage prices. They can determine if they need to store grain or not.”

Better cost accounting

Sherrick adds that along with price protection, better cost accounting systems may be needed for larger operations, “Cost accounting and revenue management are the two sides of the margin management effort,” he says. “Understanding price structures and costs on both sides of the equation seem equally important.”

Scoville says its important to have a banker who understands a grower’s production plan and risk management tools. “You need a banker that supports you,” he says. “In reality, the idea of any hedging program is to make sure you’re still in business the following year and beyond. “If you can work with your banker and have money to run a good hedging program, you may not need to hire an extra person to manage those margins.”

Will Margin Protection Insurance help?

A new USDA Risk Management Agency tool, Margin Protection (MP) Insurance, may further help growers manage an unexpected decline in their margins.

Monte Vandeveer, Kansas State University Extension ag economist, says MP was expanded to most Corn Belt states for 2018. Signup for 2018 MP coverage for corn, soybeans and spring wheat ended Sept. 30, so signup numbers are just coming in and the jury is still out on how it will ultimately benefit growers.

“We’re still getting a handle on how well it might work for us,” Vandeveer says. He says one negative of the program is that coverage is based on the county yield and the amount of input quantities projected to produce a covered crop.

“Farmers can’t use their own yield and input numbers, So MP’s effectiveness depends, in part, on how closely a farmer’s operation tracks with the county average,” he says.

In measuring MP premium costs for a southwestern Kansas county with an average corn yield of 182 bushels/acre, Vandeveer says the cost for 95% MP coverage is about $43 per acre. For 75% coverage, it is about $9 per acre.

Inputs covered include nitrogen, phosphorus and potassium in fertilizer and diesel fuel. “Growers can receive a premium credit if they combine MP coverage with a Revenue Protection (RP) policy,” Vandeveer says. “In that situation, farmers will have to gauge if they would be better off expanding their RP coverage to say 85% from 80%, instead of buying the MP insurance.

“We need to do more research to better understand how much protection we’re really getting.”

For more on Margin Protection insurance, visit K-State AgManager site

A frequent Farm Futures contributor, Stalcup writes from Amarillo, Texas.

 

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