Ask yourself if your 2017 break-even yield is near, or well below, your 5 year production average. If it is near, then there isn’t much wiggle room, is there? Everything needs to go right, including the external factors you cannot control, like weather.

Does your 2017 crop plan include a sensitivity test? What is your sensitivity to a 10% decrease in yield? What is your sensitivity to a 10% decrease is price? How close do either, or both combined, bring you to break-even?

To Plan for Prosperity

To quote my old friend Moe Russell, “What rabbits are you chasing?” Using Moe’s analogy, the rabbits you should be chasing are found in your operations costs: machinery, labor, repairs & maintenance, fuel, etc, and in your overhead costs: interest, carrying costs, etc. These are the internal factors, the factors that you can control.  And if these have gotten out of control, even free land won’t be profitable.

For many it is measured by a tangible: number of acres under cultivation, number of combines in the fleet, etc.
For others, it is an intangible: family harmony.
Most of the time though, year by year success is measured in bushels.

Here is my response to a tweet just the other day:

Profit is always the supreme success criteria. Generally, I stop there because so much of the focus at the farmgate is primarily, almost exclusively on production, and it drives me crazy! But we simply cannot ignore the basic tenet of primary production: you need the bushels!

In the commodity business, and I don’t care if it is grains, livestock, oil, or minerals, the only businesses that produce commodities with consistent profitability are those that produce at the lowest cost per unit…period.

What’s the best way to lower your cost per unit? Produce more units, and in this case that means more bushels! Of course, the caveat is that you must produce more bushels without incurring more cost, or at least if costs must increase that their increase is not linear to (ie. less than) yield increase.

I am continually challenging my clients to find ways to reduce their overall costs. In an industry that has dedicated immeasurable amounts of focus on production, it is not unreasonable to admit that many farms are already producing maximum yields for their region, soil type, weather patterns, etc. Without further advancements in plant genetics, increases in yield beyond the average will mostly be achieved by the good fortune of ideal weather during the growing season.

Control what you can control (your costs) and accept what you can’t control (the weather.)

Direct Questions

How do you calculate your Unit Cost of Production (UnitCOP)? Do you calculate it at all?

How do you determine when the chase for more yield is no longer profitable?

What strategies do you employ to reduce your cost per unit?

From the Home Quarter

As read in the tweet above, “How about net profit?” Profit is the reason we’re in business, is it not? A business without profit is not a business, it is a charity!

Business is always evolving, growing, changing…maybe our definition of success should change too.

Late in 2015, I picked up on some interesting farm financial info during a presentation I attended as a part of CAFA. This information represents farms from a geographically vast cross section and revealed some interesting trends:

1. Gross Revenue per Acre has Trended Up

With 2007 being the base year with a value of 100, and also being the first year of the bull run in commodity prices, we can clearly see that while gross revenues are trending up, there is still great volatility in gross farm receipts. True, weather anomalies had a significant effect, but that’s farming, isn’t it?

2. Investment in Crop Inputs per Acre has Trended Up

While gross revenue has seen volatility, and for three years including 2009-2011 gross revenue was at or near 2007 revenue levels, investment in inputs has only once seen a reduction year over year. In 2013, investment in inputs was 77.5% higher per acre than it was in 2007.

3. Gross Margin per Acre has Trended Up

While gross margin is trending up, there was a significant decline in 2009 from the previous year that extended right through 2011. Even by 2012, gross margin had not returned to 2008 levels.

4. Operating and Fixed Costs per Acre are Trending Up

This figure would represent operating costs such as fuel, labor, and equipment costs, as well as fixed costs such as interest, land, and building costs.  Notice the steady increase that has never went down year over year, even through the low margin years of 2009-2011 operating & fixed costs continued to rise.

5. Net Income per Acre has Rebounded from Significant Reductions

Net Income represents what is left over after operating your business, that profit which remains to cover administrative costs, make principal loan payments, and cover that other insignificant cash requirement: living costs (that was sarcasm if you couldn’t tell.)

In this illustration, we have calculated Net Income simply as Gross Margin LESS Operating & Fixed costs. Here we see that the low margin years of 2009-2011 actually extend right to 2012 with net income still below that of our base year 2007. This is the residual effect of increasing costs during a period of low margins (2009-2011) by continuing to have a negative effect on what would otherwise be a successful year in 2012.

Everything Dips but Expenses

This chart illustrates a dangerous trend: even when income goes down, operating & fixed expenses are allowed to continue to rise.

By the end of 2011, net income had dropped to less than 30% of 2007 levels, yet operating and fixed costs were over 145% of 2007 levels. It took 2013 bringing about the largest crop in maybe forever to elevate net income back to 2007 levels.

Direct Questions

If Net Income represents the funds you have generated to cover living costs and make loan payments, how well does your worst net income from the last 10 years cover your living and loan payments in 2016?

What does the trend of your gross income, input costs, operating costs, and net income look like since 2007? Is it similar to what’s been presented here? What changes have you made to your operation based on your own information?

Gross margin should ideally be in lock step with operating and fixed costs. If you aren’t increasing your gross margin, why are you increasing your costs?

From the Home Quarter

This is a very telling experiment, but it is not the rule on all farms. The information presented here is an average across a list that spans all regions of the prairies, but heavily weighted on Saskatchewan. The experiment gets more interesting when you apply it to your own business. To lean on the 5% Rule first promoted by Danny Klinefelter, if in 2013 you could have been 5% better than the average in gross revenue, input costs, and operating & fixed costs as presented here, your net income would be 44% better than information presented, and index to 152.14% of the 2007 base year.

How does that sound?

Do you build your crop plan in an effort to generate sufficient gross margin to cover operating and fixed expenses, or do you budget your operating and fixed expenses to fit within your typical gross margin?

For most high cost operations I speak with, they know their costs are high and then find themselves working hard to generate adequate gross margin to cover their costs and , hopefully, leave a profit at the end.

The challenge that many high cost operators are facing is the run up of their expenses during the recent string of bullish years (land, buildings, equipment, pickups, etc.) and are now trying to manage those residual expenses during a period of tighter margins. They are focusing heavily on one of two areas:

1. Seek out every opportunity possible to increase yields and to expose marketing opportunities, or
2. Cut expenses to a level more in line with their farm’s historical gross margins.

It seems that the most common strategy that would fall under Point 1 above is to bring lentils into the crop rotation for 2016. The high prices are just too tantalizing to bear for most high cost producers. We will see lentils being grown in non-lentil growing areas in an effort to boost gross margin. I spoke with a young seed grower this month who told me he received a call this winter from north-east of Prince Albert looking for lentil seed. Good luck with that.

I learned of another operation, in an area that is typical for lentil failures, that dabbled in lentils in 2015. While this region can typically produce 30-50 bushel pea yields, this farm enjoyed a solid 5 bu/ac lentil yield. What is the opportunity cost of using land for a 5 bu lentil crop that could have produced a 30 bu, or even 50 bu, pea crop? Chasing rainbows? I’d say so.

A number of my clients are focusing on Point 2 above, and have been quite successful in reducing the one cost that is most controllable, yet has gotten quite high over the last few years: they are selling equipment to reduce their overall equipment cost. Whether it be liquidating the extravagant tillage tool that is only needed once in a while, moving out that sprayer that is too big for the farm size, or not acquiring that “nice to have” tractor, these farms are working to bring, and keep, their costs more in line with their expected gross margin.

Moe Russell has been quoted in these articles before, and he is on record saying, “Over the long term, the price of agricultural commodities will level out at the cost of production of the highest cost producer.” Essentially, if you’re a “highest cost producer,” over the long term you’re looking at a break even.

Direct Questions

What strategies have you employed to manage costs in the wake of tightening gross margins?

Do you budget your expenses to a level your gross margin will cover, or do you try to achieve gross margin to cover existing expenses?

From the Home Quarter

One of these approaches is top-down, the other is bottom-up. If you caught my presentation at Sask Young Ag Entrepreneur’s Annual Conference earlier in January, then you’ll have already heard my explanation of why top-down is better.

Top-down is managing your farm by budgeting your operating and fixed expenses to fall in line with your typical and expected gross margin. You have likely enjoyed a regular profit.

Bottom-up is reacting to a long line of expenses that were incurred during a short period of high profitability by trying to create a gross margin that is not very likely.

The view from the top is better.

1. Evaluate actual yields against expected yield
Determine why your yields did, or did not, meet expectations. Not meeting expectations could
be positive or negative, and knowing what you did to control the outcome is important to either
repeat the practice, or learn from the shortcoming.

2. Assign a value to your production
This will be a combination of the prices you’ve already contracted and the current street price
on unpriced grain. Be accurate here; it does you no good to overstate the value or quantity of
your inventory.

3. Determine your current Working Capital
Once you’ve got a value for your total grain on hand, consider the rest of your current assets
and current liabilities to determine your working capital. This is the point in each operating year
(right after harvest) where working capital should be strongest. If it currently is not, seek help.

4. Production Cost and Fixed Cost Review
Looking at your whole operation as one figure does not provide sufficient information to afford
opportunity to increase management and profits. Break it down by crop and by acre. Where are
your positive points? Where are your stress points? What was your equipment cost per acre on
your cereal crops in 2015? What is your unit cost of production on that new land you rented this
year?

5. Field and Crop Analysis
Which fields were profitable? Which crops were profitable? Did you have significant variability
in some fields and/or crops? If so, how are you managing that?

6. Cash Flow Projection
Working capital versus future cash obligations gives you a clear understanding of what your cash
flow will look like over the next several months. Consider your expected cash flow in the near
term with your projections for 2016 (you will be working on those, right?) Does this affect your
expectations for next year?

7. Current Year Tax Analysis
There are less than 10 weeks remaining in the calendar year, and if your year-end matches the
calendar, you’ve got a small window of time remaining to determine what your tax situation will
look like and enact prudent business decisions accordingly.

8. Accrual Financial Statements
Whether you are incorporated or not, you should be having your accountant prepare financial
statements. If those statements have not been accrued in the past, please start now. Accrued
financial statements are the only way to truly gauge your business performance for the fiscal
year. (HINT: old statements can be accrued and presented again for management purposes.)

From the Home Quarter

One of my favorite adages is “If you don’t measure it, how can you manage it?” You’ll notice that the
essence of the points in the check list above is heavily weighted on measuring results. Any advancement
towards innovation in your business is lost if results are not accurately measured. Take the time now
that you’ve got the time to collect your data, analyze the results, and manage your performance.

Over the winter, an old colleague and friend made the following tweet through @RCGFarmWise:
Moe Russell has spent well over 30 years in farm finance
and management, and he has been tracking this kind of
info for a long time. I trust his integrity and his
information. Essentially over 5 crop years, this says that
farmers have increased equipment costs 100% faster
and land costs 400% faster than they’ve increased input
costs. In a time of high commodity prices with yields that
were typically above the long term average, this was not
uncommon.

Recently I took part in a Farm Business Development Initiative (FBDI) seminar that brought together
approved consultants and learning providers (of which I am both) to discuss updates to the program.
(Lean more at https://fbdi.gov.sk.ca/) During a conversation there, I overheard one attendee saying
how he listens to farmers “bemoaning the $60/ac they spend on seed, but nary a word to the $60/ac
increase in equipment costs they just took on.”

It is not surprising to see farmers looking to inputs first when trying to find ways to cut costs. We justify
it by lamenting increases to seed, fertilizer, and chemical prices. We validate cutting inputs by
acknowledging that inputs require the highest cash cost per acre of anything else on the farm. There are
sound ways to cut inputs; I was enjoying listening to many clients describing how they are using generic
herbicides this year, focusing heavily on scouting to verify the need for fungicides versus just spraying
anyway, etc. But when I heard one who wanted to eliminate a broadleaf herbicide in his cereals to cut
costs, even though I’m no agronomist, I quickly brought risk management to that conversation. Every
decision needs to have a risk/benefit or cost/benefit consideration. There is too much at stake!
More to the tweet above, looking under the right rock is not easy because it will force each of us to
acknowledge how and where we’ve allocated our capital. If we know we should not have increased our
“operations” cost, it’s difficult to face that reality, swallow pride, and make a better (or corrective)
decision. This is magnified in year like 2015 when excess moisture ahead of seeding turned into drought
for most of the growing season, and adding to that the late spring & early fall frosts, we could find that
many will miss their production targets. Are you confident you were using the most efficient agronomic
plan possible? Will your “operations” costs be harder to manage with missed production targets? Will
you be looking under the “inputs rock” to find ways to cut costs?

It has been said many times that “you cannot shrink your way to greatness.” Cutting inputs for the sake
of reducing costs is “shrinking” your ability to generate strong revenue. Even the best marketing cannot
make up for lost production. Your priorities need to continue for you to be:

1. The most proficient manager you can be to build a strategic and tactical plan that maximizes
ROI, personal wealth, and family values;

2. The most efficient producer you can be to lower your Unit Cost of Production;

3. The most equipped marketer you can be to hedge market risk, and generate sufficient gross
margin.

By misplacing your cost cutting priority onto the critical facets of your business as listed in the 3 points
above, you would be doing more harm than good, despite best intentions.

Direct Questions

Where have your costs experienced the greatest increase (inputs, operations, facilities)?
In recognizing the 3 critical facets above that require your full investment (management, production,
marketing,) where can you find costs that can you live without?

How confident are you in your awareness and abilities to enact appropriate cost management
strategies?

From the Home Quarter

You won’t hear me condone a general prescription of “more fertilizer,” but you will hear me advocate
for “better use of fertilizer.” It’s not about the producing biggest yield; it’s not about producing at the
lowest cost; it’s about producing the best yield at the most efficient cost. And the most efficient cost
also refers to “operations” and “facilities.” The allocation of your finite resources to those costs also
needs to be highly efficient. As a banker friend of mine likes to say, “Your crop doesn’t care what color
your equipment is.”
…or how new it is.
…or how much rent the landlord is squeezing out of you.
The purpose of your business is to grow your profits, maximize your ROI (return on investment,) and
increase your wealth. Spending over $200/ac on “operations & facilities” costs will not get you there.

Based on third party feedback, meaning info shared with me by a farmer from his/her conversation with
a friend/neighbor/competitor, most decisions to take on land are being justified under the guise of
“reducing equipment costs per acre” and/or “the drive to be bigger.”

Popular ag-economics has drilled in to everyone’s head that fixed costs, like equipment, need to be
spread out over more acres to reduce the fixed costs per acre. This is simple arithmetic, and is
mathematically correct if we stop there. Stopping there allows us to feel good about the decisions we’ve
made to increase our fixed costs because “over ‘X’ acres, we’re only spending ‘Y’ dollars per acre.”

Of all the costs that farmers face, the costs they have most control over seem to be the costs that are
least controlled. MNP has coined the term LPM, and what I’ll call “operations” are a farm’s labor, power,
and machinery costs which have ballooned in recent years. Next in line is Land, Buildings, and Finance
costs, or what I’ll call “facilities,” which have also grown significantly. Increase land costs (rent) to justify
increased equipment costs: think about it, we’re increasing costs to validate increased costs…
We expect to make a profit from taking risk. The more risk we take, the more profit we expect. My
concern comes from witnessing decisions that magnify risk and leave the expectation of profit as a
secondary, or even tertiary, consideration.

Direct Questions

Take a look at your expected gross margin this harvest. How much gross margin will you have available
to contribute to “operations,” “facilities,” administration costs, and PROFIT?

What is your “operations” cost? What are your target costs for “operations?” Did you know the most
profitable farmers keep their “operations” cost below $100/ac?

Have you traced your line from gross revenue and gross margin through to costs and down to profit?
Where can you improve?

From the Home Quarter

We cannot eliminate risk, we can only manage it. We cannot eliminate expenses, we can only manage
them. We cannot manage what we do not measure. If the purpose of your business is to increase profits
and grow your wealth, should you not ensure that the risks you take and the expenses you incur fit into a plan
for profit?

Understanding Costs – a graphical simulation

In the example above, which illustrates a generic but common scenario on average grain farms in 2015,
a net loss of $9/ac is expected. But the top 10% of farms with a similar gross margin could show a net
profit of $40/ac, simply from excellent management of their controllable expenses: operations, facilities,
and admin.

I haven’t done the research, but it’s fair to say that we’d be hard pressed to recall a year when we’ve
had such a string of days where the daily low temperatures are well below freezing. Word has it that
farmers in many areas now are beginning to prepare for reseeding.

Show of hands: how many built reseeding into their 2015 crop plan? I didn’t think so. How many of you
who are reseeding are rejigging your budget and projections? It better be all of you.

It’s not just the extra cost of seed, fuel, wages, etc. It also means later emergence and maturity which
will impact yield, and maybe quality. For how challenging it has been to deliver grain in the last few
years, if late maturity means you now cannot deliver off the combine in August or September as per
your contract, will you be forced to wait until December, or even March? Have you considered how this
could impact cash flow?

Don’t get lulled into oversimplifying the adjustments to your projections. It’s easy to just add in cost for
more seed. But a couple bucks an acre here for labor, and a couple more bucks there for fuel on the
extra pass add up. And I don’t know of too many 2015 projections that have much wiggle room.

Direct Questions

Have you provided realistic amendments to yield and price projections based on reseeding dates and
rates.

Have you considered how the later seeding dates due to reseeding will affect your new crop delivery
opportunities, and therefore, your cash flow?

Do you have sufficient working capital to get through this unplanned extra cost?

From the Home Quarter

Anyone who is dealing with Mother Nature’s blindside string of frosty nights will be significantly
impacted in all 3 critical areas of their farm: production, marketing, and financial management.
Consequentially, the other critical areas of your business will also be affected: family, wealth, and
potentially your health.

You must, at your very first chance, update your projections for 2015 with realistic and conservative
information. And for goodness sake, let your lenders know ASAP, not just next spring when you’re doing
your annual review.

This bolsters my argument for strong working capital. Every farm, your farm, is at risk of a blindside
attack at any time from a variety of sources. Adequate working capital is the best way to ensure you’ll
get through it.
If you’d like help establishing strategies to ensure you build adequate working capital,
then call me or send an email.

Proponents say that variable rate is not a treatment, but a management practice. They would be correct.

I’ve watched in awe the business men and women who recognize the benefits of increasing their
acumen in a certain aspect of their farm. One of those is precision farming/variable rate and it is
awesome. In fact, I believe that in the future VR will be the second greatest determining factor affecting
gross margins, second only to marketing of course.

But what is more awesome is seeing those farms that have taken precision farming into the offices and
applied it to financial management practices. Think about this: it was early December 2013, right after
the largest harvest in almost forever, as commodity prices were already on a crazy carpet for a ride
down the trading charts. I was in a conversation with an aggressive 30-something farmer when he said,
“I’m looking forward to $8.50 canola and $4 wheat, because I know I can still make money at those
prices and a lot of guys can’t. That’s going to create opportunity for me.”

You’ll recall Issue #3 of Growing Farm Profits Weekly on Cost of Production? Well, this guy knows his
costs on everything, right down to the penny per acre. THAT is precision farming!

Now imagine how easy it is for this farmer to make the decision on if he should invest in variable rate
right now or not, considering he knows his costs to the penny across his whole farm. He can quickly and
accurately calculate the projected benefit against the capital cost to invest in the technology. He isn’t
making decisions on emotion. He isn’t making decisions on pride (being the first guy in town to VR his
whole farm.) He’s making decisions on an expectation of profit. And trust me, his net worth statement
shows that he’s made several profitable decisions.

Direct Questions

Your farm requires excellence in 3 areas: production, marketing, financial management. Are you
focusing heavily on one or two areas to the detriment of the others?

Are you meticulous where your skills and interest lie, and improvident elsewhere?
Would decisions be easier to make if you knew exactly your financial position at all times?

From the Home Quarter

It’s been said time and time again that “you can’t manage what you don’t control.” Precision farming,
whether it’s in the field or in the office, is all about taking full control; it’s about collecting and using
data. It is projected that when under full VR, your farm can reasonably expect to gain ~$35/ac in a
combination of costs savings and increased yields once the practice has been in place for a number of
years. How long will it take to achieve a $35/ac benefit from implementing precision farming in the
office? I’d say pretty quick, depending on how committed you are to it. Plus, the capital investment will
be a lot less too.

Let me be very clear: cost of production matters every year. Period.

Cost of Production is the most basic principle that must be employed when making marketing decisions.
If you don’t have a clear understanding of your COP, then you are putting the survival of your business
at grave risk. Why? Because how would you know if you’re selling for a profit or not?

The WP article states, “A 38 bu. (canola) crop and a $9.45 price could yield $70 per acre before labour
and equipment costs.” That’s nice, but why would we not include our labor and equipment costs? Will
the crop magically seed and harvest itself?

COP only begins with your seed, chemical and fertilizer costs. It must also include all other operating
costs AND your fixed costs.

Now work back from your actual, or projected, yield and we come to the real figure that matters: unit
cost of production.

If you know that it costs your farm $6 to grow a bushel of canola, isn’t a $9/bu selling price a nice
target? By the way, that’s 50% ROI.

Direct Questions

What was your gross margin per acre in 2014?

Do you include your fixed costs when working out Cost of Production calculations? If no, why not?
How do you know what is a profitable selling price for your crop if you don’t know what it cost you to
grow it?

Do you discover whether or not you’re profitable only when you receive the accountant prepared
financial statements?

From the Home Quarter

In the simple calculation of “Revenue – Costs = Profit,” how can we be expected to make profitable
decisions without intimately knowing our costs? Every business that produces anything, from ocean
freighters to widgets, knows exactly what it costs to produce one item. Why doesn’t every farm know
their costs the same way?

As a special offer to the readers of this blog, I will conduct a Farm Financial
Review™ for up to 5 qualifying farm businesses at $475 (normally a $875 value.) This will include a
review of your 2014 financial results and a Cost of Production Analysis. Work must be booked by the end
of January and completed by the end of February. Please call or email for details.