New Year’s resolutions are really an effort to change unhealthy habits or adopt new ones to improve your life or business. As we think about recent shifts in the farm economy, it’s a good time to evaluate 5 areas that may need an overhaul in your business for 2016
Resolution #1 – Know Your Costs.
I often hear the old adage “You can’t control what you don’t measure” in my office and it’s true. Knowing your costs, good or bad, is the first step to managing them. As we move into a time when prices and costs have squeezed a nice profit margin into little or no profit, knowing your costs may be difficult, but that doesn’t make them less important. It seems agriculture is one of few industries where it is common to produce a product without detailed cost projections. Maybe it is because farming/ranching is often viewed more as a lifestyle rather than a business. Maybe it is the way you were taught by your parents and grandparents who ran the business successfully for many years. Or maybe it is just because the ability to set a price above cost of production rarely exists. Regardless, it is dangerous to keep doing what you’ve always done without an idea of what profit there will be. If you wait until the end of the year to see how much money is left over, it is too late to “unspend.”
Start with accurate books. I know how hated the task of bookkeeping is for most producers. Many will stay up late into the night before an appointment because they’ve put it off all year or just can’t stand to waste daylight on accounting. If you can’t or won’t do the job, find someone who can help you. Most accounting firms offer some level of help in keeping records.
An accurate set of books is one that is reconciled to the bank statements (including loan statements) and accounts for all transactions. It accurately codes expenses, especially the big co-op bills that may pay for many types of expenses, including personal use items such as fuel or tires that need to be separated out. We encourage keeping track of quantities sold so we can be sure that sales match production and prior inventories. It always amazes me when we find 10,000 bushels at an elevator or in a bin that someone has forgotten.
Taking book work one step further may involve breaking down major expenses by enterprise. This means splitting the seed bill among corn, soybeans and wheat (or whatever crops you have). Try to do this with the major expenses: seed, fertilizer, chemicals and crop insurance. These expenses make up the largest group of expenses and will make the most impact. Items such as cash rent or utilities also can be split per acre; however, these per-acre costs rarely differ among crops so don’t waste a ton of time splitting utilities monthly. I find that level of detail tends to make most individuals burn out and give up on splitting out any expenses. For those expenses that need to be split evenly over all acres, just make a one-time annual allocation for those expenses.
Resolution #2 – Control Family Living.
For three years in a row now, out of pocket family living costs for the farmers we work with have hovered just under $100,000 on average. As we see profitability decline, many operations will need to pull back on family living. It’s important that you consider your income potential and make sure your family living fits under that. A farm with $75,000 of family living and $50,000 of income is in more trouble that a farm that spends $150,000 but makes $250,000.
Like farm costs, we probably won’t find the cuts in a single category, but rather it will be important to trim as many costs as possible from as many categories as possible. It’s hard to imagine a $5 coffee a day makes much of an impact, but that it adds up to $1,800 a year. If you can find 10 things like that to cut, it’s $18,000 and that starts to make a significant impact.
If you need help with a non-farm budget, there are a lot of personal finance aids on the internet. You will find information on how to establish a budget and how to stick to it. One of the simplest ways may be to put yourself “on a salary.” When your personal expenses have easy access to a large operating note, it becomes easy to overspend. Try setting up a separate account and transfer a predetermined amount from the farm account to the personal account each month. It will be as if you are a wager earner and it will be easier to keep yourself from spending more than you are making. You can even get smart phone apps that allow multiple family members to update a budget as they spend money. This accountability will keep you following through with your plan.
Regardless of how you set up your budget, you need to make sure your family understands why you are setting the budget and backs the effort. Having one spouse on a budget and the other continuing old habits will only cause conflict and won’t solve a spending problem.
Resolution #3 – Evaluate Your Debt Load.
The average debt load for farms included in the Nebraska Farm Business averages reached just over $1 million at the close of 2014. In 2004, the average debt was just around $450,000. In other words, during the 10 years of highest profitably on record, the total debt carried by the average farm doubled. Knowing that some operations got out of debt during this time, it means some other operations increased their debt MORE than double.
Reducing debt load requires an operation to recognize taxes. Principle is not a deductible expense and most costs that incurred the debt have been previously deducted (operating costs, equipment depreciation, etc.). Although paying taxes to reduce debt seems counterproductive, it really is the only way. You must be generating more cash income than you are expensing in non-deductible expenses (namely family living, principle, and income taxes) to have cash available for extra debt reduction.
Debt is not necessarily a bad thing and is certainly a helpful way to grow and manage a farm business, but the more debt you carry, the more risk you carry. As income drops, the ability to repay drops. If you believe we are in a long-term down cycle, it’s important to get debt under control. A high debt load going into a downturn means the operation has less flexibility to take advantage of opportunities that may present themselves with assets that are “on sale.”
Besides total debt increasing, we are seeing a deterioration of the average current position. This may be a result of some purchases being put on the operating note that might have been termed out (both land and equipment). It’s not too late to fix this problem by simply refinancing the operating note into a longer term. Interest rates are good and terming out the debt will free up working capital and give you more time to repay. Remember though that refinancing debt isn’t a fix-all solution. I relate it to a Band-Aid. A Band-Aid will help a small problem heal faster but if the wound is large a Band-Aid isn’t going to do the job. If you have a major bleed in the efficiencies of your business, refinancing isn’t going to fix the problem.
Resolution #4 – Select Inputs Carefully.
Almost 35% of the total cost to produce an acre of corn is comprised of four categories (seed, fertilizer, chemicals and crop insurance). These inputs are obviously important to the bottom line of net return. Re-evaluating which inputs to buy and how many additives to include will be imperative this year. Carefully weigh the cost of the input versus the expected return.
For example, consider the cost of applying additional fertilizer expected to provide a yield bump of 5 bushels per acre. If the extra fertilizer costs $25 per acre, you need to be able to get $5 per bushel for the crop or it doesn’t make sense to spend $25 per acre to only get $20 of extra income. Remember that decisions made when corn was $6 will be very different now that corn is $3.50. You’ll need to re-evaluate the production practices you put in place over the past three to five years and make sure they still make sense.
Also consider shopping around for inputs. While loyalty and trust are important in any business relationship, it’s also important that you get the best price for your inputs. Shopping around and keeping your suppliers competitive will help reduce your costs without hurting yield potential.
Resolution #5 – Watch Lease Agreements.
In our group an average 31% of corn production costs, for example, come from cash rent. One of the most frequent questions I get is about cash leases and what to do. Landlords want to increase the rent because taxes are increasing. Tenants want to decrease the cost because commodity prices have decreased. There is no right answer in this battle, but the reality is that the free market doesn’t seem ready to fully back off. You may push the pencil and find that $275 is the most you can pay per acre, while plenty of producers out there are willing to pay more. Maybe their costs are lower than yours. Maybe the cycle will turn yet again and their bet will pay off. Maybe their desire to farm more at all costs will end their farming career.
Regardless, this decision is strictly a personal decision. Your ability to pay may be affected by several things:
- The number of acres involved. You can probably afford to over pay for a longer term for an 80-acre plot if it’s just part of your 2,000-acre farm. If you are overpaying for 1,800 of your 2,000 acres, it’s going to cause a larger negative impact.
- The length of the lease. Losing money to keep control of an income-producing asset in the short-term may be a good long-term strategy, but if you have to lock into three to five years of high rents, it may be too long to sustain losses.
- The financial health of your business. This may be the real key in your decision to keep going. If you have a low debt-to-asset ratio, you have the financing room to take the risk of short-term losses. You can decide if the long-term benefits outweigh the short-term risks. If, on the other hand, your debt load is already 70% of your assets, you may not get to make that decision. Your risk level may already be too high to afford short-term losses.
Flexible cash leases would certainly be a great solution but coming up with a strategy for how to calculate that is beyond tough. Calculations that get too complicated often confuse everyone. Even simple arrangements can lead to “unfair” situations. Is it fair for the landlord to share in price, production and cost risk to the tenant? If so, shouldn’t the tenant share in cost risk (tax increases) with the landlord? Can we concede to only flexing rent based on price risk and let both parties manage their own cost-control risk? I can certainly come up with significantly more questions regarding flexible leases than answers. The theory is certainly right on. The application of the theory may still be difficult, but I do know there are LOTS of arrangements out there.
We don’t know how long we will be seeing tight margins. Production agriculture is a cyclical business where tough years seem to be more common than good ones. In reality, the world needs to eat so eventually the supply and demand functions will have to work so that someone will make money growing food. It may easily be tight enough that you have be an above average producer to be competitive.
Those producers who are prepared to balance the tight rope of controlling ALL costs through these upcoming tough years and are prepared to take advantage of opportunities to make money when they present themselves are the one who will be in business in 10 years. How do you do that? It all comes back to Resolution #1: Know Your Costs. Then you’ll be prepared to make quick, yet accurate decisions based on real information.