All of us in the agricultural industry know that tough times are part of our business, and it looks like 2017 will bring plenty of challenges for nearly all sectors of grain and livestock production. We can also be optimistic that this down cycle will be replaced by better times at some point down the road.
You can use the coming months to hone the financial and production skills in five key areas that will see you through any cycle. The work you put into your business will help you weather the current economy – and position you to maximize profits in better times.
Gain a better understanding of your balance sheet. It’s important to complete annual balance sheets on the same day each year. The industry standard is year-end, whether calendar or fiscal year. If you choose to do yours on a different date, make sure you continue to do it on the same date going forward. This can help you to track trends and spot issues before they become a problem.
One of the most important and undervalued measures is working capital (current assets minus current liabilities), which for many producers has deteriorated in this economic environment of low commodity prices. Massive price swings in grains and livestock, paired with 2016’s erratic rainfall, has hit some producers’ bottom lines harder than others, including among neighbors growing the same crop in the same county. Picture neighbor A, who catches a few extra inches of timely rain and produces an above-average crop that allows her to maximize profits on some timely grain sales. Meanwhile, neighbor B missed out on some timely rains and grew a crop at or under his crop insurance APH (actual production history). Neighbor B also ran out of time and bin space and sold grain in the late-summer months during the time of lower commodity prices. These two examples illustrate the disparity of several hundred dollars per acre that played out during the 2016 growing season.
Refinancing debt can be an effective way to rebuild working capital, and interest rates are still attractive. Admittedly, it doesn’t feel good to take something that’s “paid for” and use it to refinance operating debt. But was it really paid off, or did the debt just get put in a different place?
Evaluate machinery, equipment and vehicle investments. As a rule of thumb, lenders like to see less than $500 to $600 per acre invested on these items. Diversified operations that include livestock or custom work on additional acres need to allocate those assets to each enterprise. This is a balance sheet measure, and it plays directly into return on investment. As you learned in Economics 101, producing grain is generally a perfectly competitive business; the going price for a specific commodity is the same for you and your neighbor, regardless of differences in the cost of production.
From a cash flow perspective, lenders typically like to see less than $60 per acre going to payments for machinery, equipment and vehicles. After adding in fuel, repairs, labor and depreciation, the total cost should be less than $100 to $110 per acre. The Iowa State University annual Custom Rate survey also indicates this is about the total cost if you were to hire an acre fully custom farmed.
This isn’t an argument for selling all your machinery and hiring everything done. But you should analyze each pass you make through the field to identify ways you (or someone else) could do it cheaper without sacrificing quality or timeliness of work. On the flip side, look for opportunities to do additional custom work to increase revenues.
Look at your crop operation on a field-by-field basis. Rather than adding up all of your expenses and dividing it by the total number of bushels your operation produces, do the same thing on a field-by-field basis. Producers who break their costs down by field are better able to make educated and timely choices about possible opportunities. If you realized that a certain rented farm had a $5-per-bushel breakeven with normal yields, how long would you continue to rent that farm? Letting go of land can be an emotional decision, especially if you have rented it for several years. Consideration also needs to be given for location and possible opportunity to purchase in the future. Producers also hold onto rented land in the hope that it will be profitable again when commodity prices recover. That may be the case. But ask yourself this: If the rent is too high now, what are the chances the rent won’t go up further if commodity prices rally again? Will the landlord incrementally increase rent to remove any chance of profit, regardless of price and yield?
Evaluate family living. Look at one month of expenses, multiply the resulting number by 12, and then add in the other non-monthly expenses that you incur throughout the year. If you tell yourself you draw $60,000 for family living expenses but you actually draw $90,000, the only person you are fooling is yourself. Many people find the actual number to be 30% higher than their estimate. Health care and other costs continue to rise, and advisers don’t advocate cutting on those essentials. The bigger thought is to have awareness for what the real number is, and consider practical ways to trim back. Knowing the totality of all of your expenses is a key to understanding the true cash flow ability of your operation.
Learn more about your business. Make it a point to learn more about your soil, seed and nutrients. Consider taking a class on agronomy, animal nutrition or marketing. Use the countless resources (many of which are free) available from credible sources on the internet to further your knowledge. Take an honest look at everything you do in your operation. Are you doing something because that’s the way you’ve always done it? Change can be uncomfortable and stressful, but often is worth doing. Lenders want to do business with people who are immersed in and passionate about their business.
Each year comes with unique opportunities and challenges, and no two operations are the same. Success comes from understanding your operation and its risks so you can make smart business decisions. Many of these decisions and considerations are complex. It is more important than ever to use (or build) a team of trusted advisers, including but not limited to your lender, crop insurance agent, tax professional, agronomist, nutritionist and marketing adviser.
Hanssen is a financial officer with Farm Credit Service of America’s Sioux Falls office.