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barometer

Farm Business Barometer

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It’s harvest time. The weather has been uncooperative. The crop is generally not ready to go. Quality is diminishing. The August and September contracts Fred* had in place will not be delivered on time, even though the elevator has room, because his grain is still in the field and not in the bins. (* Fred isn’t anyone in particular. This story is fictional, but we need a lead character and decided to call him Fred.)

Finally, it looks like the weather will break, forecasting two weeks of high pressure, clear skies, and warm temperatures. Fred even has enough help between the hired staff, and family who have offered to come home for a week or so. He must get this crop off quickly, as fast as possible. Fred needs another combine.

Fred cannot afford to think about this for too long; everyone is in the same situation, and they could be looking at adding a combine to their farm as well. He heads into town, speaks with his salesperson, and acquires a quote. It’s higher than he wanted, or was expecting, but Fred is in a bind. He just heard that there are 2 other quotes on the same unit. He writes the cheque for a deposit.

Now comes the hard part – seeing the banker.

Fred recalls the feedback he was given before seeding time: things have been a little tight, and pulling back on any capital expenditures for a couple years would be best. What if this gets declined? How will he get the crop off in time? Is his deposit refundable? Fred scolds himself for not asking when he wrote the cheque.

Fred arrives at the banker’s office unannounced. Luckily she’s in the office today. Thankfully he doesn’t have to wait long. He explain the situation: things are getting worse by the day with poor weather degrading crop quality, and thereby crop price; he has lots of help to run extra equipment to get harvest done in record time…if he had another combine. When she asks if a decent combine can even be found at this juncture, Fred proudly produces the quote he just received no more than a half hour ago. She says she’ll take a look at things, and call right after lunch.

Fred heads home. The temperature is climbing and the wind is blowing; he thinks he could maybe get going this afternoon. Everything is serviced and ready to go; after all, he’s only done 150 ac so far. Fred heads in for lunch early, hoping that will speed up the call he is anxiously awaiting from the banker. He scans his phone for afternoon market updates, text messages from any neighbors who might be rolling, and that critical phone call from the banker that just isn’t coming fast enough.

He can’t sit around; Fred fires up the combine to go out and get a sample. The wheat sample looks bleached. He figures he’ll be lucky to get a #2. Sticking his hand in the pail Fred thinks “It feels close.” He rushes back to the yard to test it: 14.8! That can go in aeration! Let’s go!

Fred reaches for his phone to let everyone know to get ready to go, but realizes he left it in the combine in the field from which he just took a sample. Fred jumps in the semi, and even though it hasn’t warmed up enough yet, he hustles out to the field. Word will get to everyone via the house phone, and they’ll get out to the field right away.

Once back in the combine cab, Fred finds a message on his phone: it’s the banker! She wants him to call her right back. He does, and the call goes straight to voice mail. Fred swears.

She calls back in the time it took to fill one hopper. As Fred unloads into the truck, she tells him that she cannot approve a loan for the combine. She says that Fred’s cash flow is too low and his debt levels are too high to take on another liability for a “nice to have” asset. She talks about other options for this harvest, and offers clear feedback on what needs to happen in the future to not have these kinds of interactions with her again, but Fred has already stopped listening because he’s moved on to thinking about who else he can call for financing, wondering if the dealers program can turn an approval in less than an afternoon…

Fred immediately calls his salesperson at the dealer, and a couple other leasing companies, to ask them to begin an urgent credit application. They’ve got all his information now; he’s been in touch with them a couple times this year already when the banker has denied his other requests. Fred begins to wonder why he even bothered with the bank this time.

An hour later, Fred gets a call from the dealer; their financing division has approved his combine loan application. The interest rate is higher than his other loans, and the payment terms are more rigid, but he is not worried about that now – Fred can get that extra combine!

Jubilation turns to anxiety: the dealer cannot deliver until next week, and it hasn’t been through their shop. Fred will need to invest a half-day to have someone drive it home (who can be freed up to do that now that the harvest is rolling again?) Fred realizes this combine will probably need some repairs and some parts (more trips to town on the weekend.) On top of all that, he realizes that he’ll have to shut down himself to go in to town, sign the loan, sign the equipment sale agreement, and hopefully get to the insurance office before they close for the weekend. At this point, Fred might as well drive it home himself!

Yup, having a 3rd combine will make short work of Fred’s 5,300 acres! He acknowledges that he’ll have a serious amount of harvesting capacity for his farm size, and despite what he was told by the banker in spring and again today, Fred still got approved the loan. And if Fred got the loan, his business can’t be in as bad of shape as the banker says, right?

Direct Questions

Why does Fred exclusively use his creditor’s approval or decline of his credit applications as the barometer of his business’ financial stability and position?

How does Fred account for the differences in lending criteria and motivations between creditors when using their feedback as his business barometer?

What do you use as your barometer of business health?

From the Home Quarter

In our story, Fred clearly does not take the time, nor does he have the interest in understanding the financial ramifications on his business from the emotional decisions he makes. He continues to forge ahead by using any and every source of credit he can grasp. What happens when his requests are denied? Is it only then that his farm is in a position of financial weakness?

When focusing on priorities, I advise my clients that there are often times more important issues than upgrading equipment and constructing more buildings because credit is (relatively) easy to get, and has been for some time. As such, using credit approvals as the only, or primary, business barometer is narrow in scope, biased in feedback, and lofty in risk.

 

even emergence

Farm Financial and Business Information – Best Practices

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Recently, I read an article that listed the “Top 10 Ag Data Platforms of 2015.” I recognized only 2 of them. Clearly, the choices available to producers in finding and using an appropriate data template is abundant. In recognizing that this does pose challenges in trying to decide which one to use, several of them offer a free trial period: use the service for a set amount of time and if you’re not happy, they’ll refund your fees. Can’t lose, right?

Like so many other aspects of life and business, going on the cheap, finding the lowest cost solution, spending as little as possible often has the opposite effect than what is desired. When I needed steel toed work boots for the farm, I used to spend about $120 for “cheap” boots from the discount or department store. The last pair I bought were Red Wing and cost me well over $300. They outlasted 2-3 “cheap” pair and my feet were far more comfortable during those long 18 hour days at seeding, keeping me less fatigued. Was there greater value in the more expensive boots? You bet there was!

If cost is your #1 concern when considering options for managing your data and business information, then please consider why you buy the name brand hand tools, cars, trucks, and farm equipment that you do? If cost was the only concern, wouldn’t we all be driving cheap $10,000 cars, using WalMart wrenches made in China, and farming with Belarus tractors?

Find what works for you and just use it. If you don’t know what works for you, then ask for help. I am meeting with an office organization expert this week to get the help I need in creating a work-space that is better organized and more suited to my work flow.

Last week we discussed “Using Your Financial Information,” but if you aren’t managing your information adequately, it will be difficult to use, and leave you to make decisions with information that is not accurate. We expect our financial institution to provide us with accurate statements, and we’d be pretty upset if the information they provided us wasn’t spot on. We need to have the same expectation of ourselves.

If doing your own income and expense entries, set aside 1 hour twice a week to input accounting data. I used to leave mine until it was time to file GST every quarter. I have found that there is value to letting my accountant’s office handle this task so I can focus on my business. In 2016, I’ll be leaving the data entry to my accountant.

The first piece of information I prefer to offer to new clients is a Unit Cost of Production calculation. This requires current and accurate figures for crop inputs, yield and price, operating costs, and overhead costs. To know what it costs to produce one bushel of canola or one tonne of barley on your farm requires accurate info, otherwise it’s still a guess! Using this accurate information is very empowering!

Here is a list of Best Practices to consider implementing for managing your farm’s financial and business data:

  • Research and fully utilize an agronomic data platform; ideally it would require minimal manual entry on your part by gleaning info from your tractor/sprayer/combine consoles, and also easily convert to your accounting software.
  • Manage income and expenses regularly: don’t simply fill the shoe-box! Designate 1 hour twice per week to data entry.
  • Evaluate the worth of your time relative to tasks you do, and delegate accordingly.
    (IE. if you’re the CEO helping the hired men sweep out bins, you’re not allocating your time very well!)
  • Consider using outside help, or a designated employee, to manage date entry if you deduce that your time is better spent elsewhere.
  • Keep income & expenses, assets & liabilities, and cash flow records current each month.

Direct Questions

How are you best utilizing the resources you have available to compile your data? Are you using the right people, or slugging through on your own?

What data and information management tools are you using? Do they satisfy your needs? How are you using the reports they create?

Does managing financial information take a back seat to other tasks? What do you need to make it more of a priority?

From the Home Quarter

Choosing an information management platform is a daunting task. But it is less daunting than trying to make informed decisions with little or no usable information. The learning curve is steep at the beginning, yet once you’ve done all your set-up, keeping it updated is relatively easy. Making information management a priority can be less easy, depending on mindset. The benefits you’ll enjoy from being equipped to make informed decisions immediately as required are similar to the benefits you enjoy from getting your entire crop seeded early into warm moist soil. Even emergence on an early seeded crop is as satisfying as highly informed strategic management decisions…and just as important!

analyzing finances at the bin

Using Your Financial Information

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Last week, we described how compiling your financial information will be beneficial to you in being able to analyze your previous year’s results so as to equip yourself in making informed decisions in the current, and future, years. This week, we discuss how to use that info.

Critical Balance Sheet Metrics

  1. Your Current Assets should be greater than your Current Liabilities by an amount that at least matches your cost to put in next year’s crop.
    Ideally, the difference between current assets and current liabilities should at minimum match your entire costs to run your farm for one year.
  2. You want your Total Liabilities to be no more than your 125% of your equity after net worth adjustments have been made.
  3. ROE is an acronym for Return On Equity. It is your net income divided by your net equity. Are you happy with the returns you’ve earned in each of the last 5 years?

Critical Income Statement Metrics

  1. First and foremost, is your Income Statement accrued? You can tell if you find an adjustment, up or down, to your income that would be labelled “inventory adjustment.” If your income statement is not accrued, call me for a quick description on how to do it yourself. It’s easy.
    Accruing your income statement is the only way to truly measure your profitability from the crop produced in a specific year.
  2. Did you have a profit? EBITDA (Earnings Before Interest Taxes Depreciation & Amortization) is a very important figure to know. It represents your profitability from operations; it shows you can generate profits. The calculation is Net Income + Interest Paid + Taxes Paid + Depreciation Expensed.
  3. Now that you’ve got EBITDA calculated, divide it by the following figures: Current Portion of Long Term Debt (found on balance sheet) + ALL interest paid (found on income statement) + ALL lease payments made (found on income statement). This is an important indicator for your lenders. This figure indicates to them your capacity to meet your financing obligations.

Critical Cash Flow Statement Metrics

  1. Cash Flow from Operations divided by Gross Sales indicates how many dollars in cash your business generates from every dollar in sales. The higher the figure, the better.
  2. Cash Flow from Operations divided by your “Property, Plant & Equipment” indicates how well your business uses its hard assets to generate cash.
  3. Cash from Financing divided by Cash from Operations indicates how dependent your business is on financing. The higher the figure, the more dependent on external money.

Solvency Calculations

Liquidity Calculations
Liabilities / net worth current assets / current liabilities
EBITDA / loan payments, interest & leases current assets – current liabilities

 

Direct Questions

Does the thought of doing such calculations overwhelm you, scare you, or just plain bore you? If the urgency of knowing these numbers doesn’t strike urgency into you, are you willing to ask for help?

How would you describe the benefit to your decision making if these figures were readily available?

From the Home Quarter

The comment has been made time and time again: “It’s easy to make money in the good times.” With tighter margins of late, more attention than ever before is being paid to management and finances. These calculations above are only a few of the measurements that you can take to gauge your financial strength or weakness.

And if you need a hand figuring out what to do next, contact me any time.

emotion

Performance Management: A Post-Harvest Checklist

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With harvest done, or nearly done, across the prairies, this is the time to engage in a little retrospect.
Recognizing the window is small (and shrinking) to get all the fall work done before freeze-up, this task
may end up a notch or two down the priority list. But nonetheless, it is important to go through this
exercise now that the crop is in the bin.

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.

information

Managed Risk – Part 4: Liquidity

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We’ve all heard the saying “Cash is King.” In my opinion, “cash isn’t king, it’s the
ACE!” Whatever metaphor you prefer, the point is that cash levels and cash flow are both critically
important to your business. So, let’s get right to four points that affect your liquidity:

1. Your view of cash.
When I was still farming, I asked dad when he wanted to receive his rent payment, now (at the
time it was late November) or after January 1. He replied, “Well, I wouldn’t mind seeing a bump
in my bank account now, but I’ll wait until January for income tax purposes. Why?” When I
admitted that at that time we had no cash and would be dipping into our operating line of
credit, he said, “I thought you said your farm was profitable.” Our farm was profitable. He
couldn’t wrap his head around the fact that a profitable farm might not have cash always at the
ready, especially a small farm still in its youth. He equated profit with cash in the bank. After
arguing the point for 5 minutes, he just shook his head saying, “I guess that why I’m not farming
any more, I just can’t take that much risk.”

What he was getting at with his final comment was how we very quickly allocated our cash that
year. With harvest sales, we cleared up all accounts payable, pre-bought some fertilizer, and
paid down our supplier credit. The bins were still full, and with more grain sales scheduled for
the weeks and months ahead, our working capital was strong.

What is the difference between cash on hand and working capital? (HINT: if your answer is
“nothing,” then think again, a little deeper this time.)

2. Your use of cash.
Over the last few years, how many new pickup trucks were paid for out of working cash or put
on the operating line of credit? This is one example of a poor use of cash. A business that is flush
with cash can be a dangerous thing in the wrong hands, but don’t fret because the laundry list of
vendors all clamoring for your money will offer plenty of opportunity for you to part with it.
Do you justify some of these types of expenditures as part of a “tax plan?”

3. Your timing of cash.
One of the major challenges for manufacturing companies is the “cash conversion cycle.” This is
the time it takes to convert raw materials into cash. This cycle happens frequently in a
manufacturing firms operating period, often several times each month or quarter (depending on
what they are manufacturing.) Your challenge in the business of farming is that you only get one
cash conversion cycle per year. You invest in inputs early, manage through a long production
cycle, only getting one chance at producing the crop that will be sold for cash, and eventually
selling it sometimes as late as half way through your next production cycle. It is this long cash
conversion cycle that makes cash management vitally important on your farm.

How long is your farm’s cash conversion cycle? (HINT: it is measured in days.)

4. Managing your liquidity.
Working capital is a component of your liquidity. Measured as the difference between current
assets and current liabilities, your level of working capital is a direct indication of your business’
ability to fund its current operations. This, or course, is critically important to your lenders.
The desire to utilize easy credit and therefore finance everything from combine belts to
hydraulic oil may sound like a simple way to keep the wheels turning. If your farm is without
cash due to poor crops/pricing/etc. from the previous year, then available credit is a lifesaver to
help you keep operating. Just remember, such a scenario is a short term solution, and by no
means can it be considered a long term strategy. Sooner or later, your creditors will tire of
holding all the risk of funding your operations. Your working capital must be built and
maintained.

How much working capital is appropriate for your farm? (HINT: it’s probably more than you
think.)

Direct Questions

How do you view cash? Does it only have value when allocated (spent,) or is it an essential asset on the
balance sheet?

If you believe cash in the bank is an indication of profitability, can you not save your way to increased
profit?

How would you describe the financing cost to your business relative to the long cash conversion cycle
and the cost of credit?

From the Home Quarter

I had heard a seasoned old banker years ago say how “farmers don’t like to have money in the bank,
because as soon as it gets there, they spend it!” When there is cash in the bank, we feel profitable, and
often the decision is to allocate that cash to another asset. Will that other asset help repay liabilities?
For as long as I can recall, this industry has always dubbed itself “asset rich & cash poor;” the push
among players has been to build equity. And while the chase for equity is noble, equity does not pay the
bills, nor does it make loan payments, nor does it meet payroll. Cash does.

We must make cash management an utmost priority. If we are relying on financing for most/all of our
daily operations (operating credit,) what will happen if/when a lender does not renew those lines of
credit? Do you recall the ruckus out of the US each time they need to “raise the debt ceiling?”
Potentially, all government operations would get shut down. Same goes for your farm. If you have no
cash, and your credit lines get called, what are your options? I can tell you, they aren’t pretty.

It does not matter whether you believe “Cash is King,” or “Cash is the Ace.” If you have neither, you
might be forced to fold.

life

Managed Risk – Part 3: Credit

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You’ve read how I am a fan of Seth Godin’s daily blog. His entry on Thursday September 17 was titled
Serving Size. He writes about how it is “our instinct to fill the bowl” with “bowl” being a metaphor that
could apply to anything and everything from our homes to our egos. For now, let’s consider the “bowl”
to be thought of as “debt.”

If you’re like most farm businesses, you’ve been getting a bigger debt bowl over the last 5-7 years. In
fact, I would bet that if you looked back at your statements from 2005, you would wonder how you even
managed to operate with such little debt (relative to what you’re carrying today.) This is not unique, and
considering western Canadian agriculture (especially grains) has been in a boom for the last 7 years or
so, it is of little surprise that debt levels have also increased.

The question then begs, “How big can the bowls get?”

Lenders love to see strong cash flow and increasing equity. Record cash receipts and appreciating land
values have bolstered lenders’ appetite to lend into agriculture. With money being as cheap as it is (low
interest rates,) farms’ debt bowls have been easy to grow.

What’s been filling all those bowls? Primarily it has been rapidly appreciating land and an insatiable
thirst for more and newer equipment. You’ve read here in the past that there is a distinct difference
between “good debt” and “bad debt.” I challenge everyone to evaluate what is in their “bowls” and
identify the “bad debt.” What percentage of your total debt could be considered “bad?”

Generally speaking, bad debt is the unnecessary debt. Often poorly structured, it eats up cash flow like a
game of Hungry-Hungry Hippos chomps marbles, and it uses up the finite space in your bowl. Yes, there
will come a time when a bigger bowl cannot be had, and it is then that many will wish they had managed
their credit a little closer.

We talked about interest rates in last week’s article, and it spawned more reader feedback than I’ve
received in a while (I’ll credit that to harvest being a greater focus than commenting back to me.) Gerry
Bourgeois, Scotiabank’s Director of Agriculture Banking for Saskatchewan & Manitoba, offered an
interesting strategy in his reader feedback: “With interest rates at an all-time low, farmers with a lot of
debt on their balance sheet should be taking advantage of these current rates to consider locking in 5, 7,
or even 10 year money.” Acknowledging that rates are still going to go up, even if it will be later than
many had expected, Bourgeois says, “I view the current low rates as a compressed spring. Once they
start moving up, they will move up quickly.” He goes on to suggest “locking in rates and using derivatives
to hedge interest rate risk” as a sound strategy many farms could consider.

“Similar to how a farmer would use commodity derivatives in a trading account to hedge his commodity
pricing, we use financial derivatives to hedge interest rates on larger transactions,” Bourgeois says.
Using what are called Banker’s Acceptances, he describes how a “swap” works as a hedge against rate
increases, and alternatively can even goes so far as to structure a “cap” on potential future interest rate
increases, functioning like interest rate increase insurance. “Utilizing these market instruments can
provide greater flexibility in your hedges down the road,” he concludes.

To put more emphasis on managing your credit, here are some focal points to get you started:

  1. Understand how your lender views your business. Are you seen as risky? Are you considered
    highly leveraged? (IE. Can you get a bigger bowl, and if not, is it right full?)
  2. Recognize how your cash flow matches up with your debt obligations? More specifically can you
    meet your debt obligations should your cash flow decrease?
  3. Eliminate bad debt, and keep it out of your operation. Just because you can afford the payments
    today doesn’t mean you should buy, and it certainly doesn’t mean you can afford the payments
    next year either.
  4. Look back at the worst year you’ve had profit wise in the last 10 years. How much debt could
    you service if that was your profit for the next 3 years? Let this be your guide.
  5. If your bowl is full, what is your strategy in case of an emergency (Eg. tractor needs an engine)
    or an opportunity (Eg. prime land unexpectedly hits the market)

Direct Questions

What are you doing to protect yourself from market changes? (Eg. interest rate moves, lender’s
adjustment to credit policy, etc.)

How can you strengthen your overall debt structure?

What happens if your lender instructs you to use a smaller bowl?

From the Home Quarter

Every business needs access to credit to facilitate growth. It is the reckless depletion of many farms’
credit capacity that will further heighten a potential cash flow crisis stemming from shrinking gross
margins. While we cannot change the decisions of the past, we can learn from them. And there is no
time like the present to take steps to improve your debt situation if it’s not currently ideal. There is no
time like the present to strengthen your credit structure to protect what you’ve built considering the
current lending environment.

There are many circumstances where it is a smart decision to get a bigger bowl, but it is often smartest
to know when the bowl is big enough, or even when to get a smaller one

farm

Managed Risk Part 1: Harvest Sales

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In an email last week, a farmer friend and former colleague of mine admitted to having 100% of his 2015 crop sold before harvest. It is the first time this has ever happened on his farm. From my years working in ag finance and farm management consulting, I can confidently say that virtually all farms are not 100% sold on new crop in advance of harvest.

As with anything, there are benefits and drawbacks to being 100% sold early in the crop season. It’s easy to identify the drawbacks: production risk (broken into yield risk and quality risk), opportunity risk (if the market appreciates after you’re sold), etc. etc. We’re not going to dwell on these because it’s safe to say almost every farmer has already spent more than enough time hashing and rehashing all the reasons why they shouldn’t sell too early. There are far more drawbacks that have been touted over the years (real, perceived, or otherwise) than I care to scribe. You’ll notice I didn’t put weather risk on the list; it is because we cannot influence or control weather. Why stress over that which you cannot control?

How about some of the benefits:

  • Reduced delivery risk
  • Eliminated market risk
  • Reduced storage risk
  • Controlled cash flow risk

When admitting his crop was 100% sold already, my friend and I didn’t get into the details of what was in place so that he felt comfortable making such a decision. He did acknowledge that prior to harvest the prices were too good to pass up. While price is an important factor, price alone is not sufficient to pull this trigger. Here’s more on what you need if you want to be a more aggressive price maker, instead of a passive price taker.

  1. Excellent relationship with your buyers.
    When it comes to dealing with quality and grading, delivery times, or anything in between, a solid relationship with the buyer of your grain is crucial. Try using a sense of entitlement when next dealing with your buyers and see how far you get. This one is obvious; we won’t dedicate any more space describing what you already know.
  2. Know your costs, especially Unit Cost of Production. As one of my favorite young farmers likes to say, “You can’t go broke by selling for a profit.” Such true words require that you know what it cost to produce a bushel or a tonne so that the price you accept is actually profitable. This isn’t an easy task before harvest, but those farms that have elevated management functions can clearly illustrate UnitCOP with allowances for deviation in expected yield or quality. Refer back to point #1 when dealing with those deviations.
  3. Abundant Working Capital.
    Any drawback, real or perceived, to selling most of your crop ahead of harvest is mitigated by having abundant working capital.
    The biggest selling benefit from having abundant working capital is being able to sell when you WANT to instead of when you HAVE to. The ability to sell on your own timeline affords you the opportunity to deliver in your preferred month, and to seek out your preferred price. Abundant working capital also alleviates the fear of costs incurred from not meeting contract requirements when aggressively forward selling. The hesitation felt from the potential of having to “buy out” a contract if specs aren’t met can be eliminated if working capital is abundant.

It is not unreasonable to see more reluctance this year among durum growers to forward price as aggressively as in the past. The fusarium fiasco of 2014 hurt numerous farms financially and created an air of hesitation. But if working capital was a non-issue on every farm, durum growers would not be shy to forward price after the 2014 experience. While none want to set themselves up for unnecessary cost incurrence, the ability to handle the potential cost alleviates the concern of incurring it.

Direct Questions

How would you rate your relationship with your grain buyers? What can be done to improve it?
How would you describe your knowledge of your Unit Cost of Production, and net profit margin?
What is your current level of working capital and what does it need to be to provide you with full confidence to aggressively forward price?

From the Home Quarter

Please let it be clear that this message is not encouraging everyone to sell 100% of new crop production ahead of harvest. Such a strategy takes on risks that not every farm can mitigate. But if you are desirous in forward pricing more new crop than you have in past years, then let this message offer you some tips on what you need to have in place to make that happen.
You may have noticed that working capital is a central theme to many messages delivered here weekly. If you are able to focus on only one priority, let it be working capital.
Our proprietary Farm Profit Improvement Program™ begins with working capital evaluations and True Cost of Production analysis. Please call or email to learn how this process can bring value to your farm.

GFP FI 4

Knowing Your Costs – Part 2: “Misplaced Priorities”

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Last week, this article weighed in on the trend of increasing costs in certain areas of the farm, namely
Operations (equipment, fuel, people,) and Facilities (buildings, land, financing.) These are the two most
controllable expense areas in farm management. These are the two cost areas that have seen the
biggest increases.

Over the winter, an old colleague and friend made the following tweet through @RCGFarmWise:
tweetMoe 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.

grain2

Knowing Your Costs

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My clients continually educate me on the regional anomalies relating to land prices, and specifically land
rents. The common opinion among most farmers I speak with is that some of their neighbors just don’t
understand how to measure costs, and this leaves many farmers (including some of those I speak with)
feeling left out in the cold as they watch land get snapped up by someone willing to pay a rental rate
that can appear astronomical.

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.”

graph16

 

 

 

 

 

 

 

 

 

 

 

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

graph17

 

 

 

 

 

 

 

 

 

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.

grass

Information Management – Healthcare vs Your Farm

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Of all of the places one can imagine, our health care system is the preeminent entity that I believe
should be leaps and bounds ahead of everyone when it comes to managing data.

Over the last year or so, I’ve listened to my father-in-law’s observations about our healthcare system as
he led the charge relating to the changing needs of his disabled sister. He described how one nurse
would come into the hospital room, ask a series of questions, make some observations, take some
notes, and then leave. Shortly afterwards, another nurse would come into the hospital room, ask a
series of similar questions (getting similar answers,) make some observations, take some notes, and
then leave. At some point, a doctor would come into the hospital room, ask a series of similar questions
(and get similar answers,) make some observations, take some notes, and then leave. Usually these
notes where made on a chart that hung outside the hospital room door.

Some thoughts:

  • The cost incurred to have 3 highly paid and very intelligent individuals gathering similar
    information would likely astound me;
  • All of the information gatherers collected similar information, and compiled it into one paper-based record;
    Could anyone walking by a hospital room with malicious intent grab someone’s chart and leave
    that patient’s caregivers without access to critical information? Why isn’t this electronically
    secure yet (it’s only 2015 already!)
  • Patients get tired of answering the same question over and over;
  • Why wouldn’t the health regions equip each caregiver with a tablet computer that brings up a
    patient’s entire health history with the scan of a QR code that could be found on the patient’s
    wrist band?

Why am I writing about this? How is this important to you? First off, our healthcare should be of great
importance to everyone. But specifically as it relates to this blog, consider the
paragraph and bullet points above, but this time let the patient be your farm and the caregivers be your
business advisor, your lender, and your marketing advisor.

Direct Questions

How much better would it be to have all of your critical business information readily available for your
strategic partners to help you more effectively and efficiently manage your business?

How inefficient is it for each party to have to ask you for the same info? Your time is worth something
too, so wouldn’t you be better off not having to run through the same routine 3 times over?

How much risk is your business at if you were to lose, accidentally or maliciously, your historical business
information?

We’re a decade-and-a-half into the 21st century, and technology is awesome. When are we going to start
trusting it and using it to its full potential?

From the Home Quarter

I believe we have the best healthcare system in the western hemisphere, and I am by no means
criticizing any of our hard working health-care providers. But I do question the bureaucracy and
inefficiency that plagues the system (at least in the eyes of this layman.) I think we could do so much
better, which would then allow those on the front lines to spend more time providing healthcare rather
than administering information.

I believe that Western Canadian farmers are of the most efficient producers in the world, and I am by no
means criticizing any of your advancements and dedication to improving your production. But I do
question the lack of urgency and the failure to recognize the importance of having up to date critical
business information readily at your fingertips. You aren’t making the same type of “life and death”
decisions that are made daily by our health-care providers, but the decisions you make for your business
will effectively set in motion the cause and effect that can lead to life or death of your business.

Call to Action – Rate your current information management practices:

1. Can you produce your working capital figure within 2-3 minutes at your computer?

2. Can you advise what your total fertilizer cost per acre is by field? By crop?

3. Can you produce a current list of all farm assets with market values?

4. Do you keep a rolling list of cash requirements for the next 18 months? (i.e. loan payments,
property taxes, insurance premiums, etc.)

5. If you’re not willing to compile this critical information, are you willing (or can you) hire
someone to do it for you?

If you’ve answered YES to at least 4/5, congratulations, you’re ahead of the curve.
If you’ve answered YES to 3/5 or fewer, then please pick up the phone and ask for help.
(Hint: I always return voice mail messages.)