By Harry Brook
Farming is big business! Just look at the cost of land, machinery, inputs! Everything involved in making a living farming is expensive and getting more so. Agriculture has benefited from a long period of farmland appreciation, which can mask some underlying weakness in an operation. Let’s look at measurement of financial health.
It always comes down to finance and numbers. One of the most immediate measures in finance health is the current ratio. Put simply, it is your current assets (crop, livestock and input inventories, cash) compared to your current liabilities (loan payments, taxes, input costs, due this year). You may have lots of land but, if you don’t have money to pay today’s bills, you are in trouble. Ideally, you’d like to have a current ratio of 1.5 or better. There is still living expenses you need for the next year too. The current ratio is also known as liquidity.
Solvency is another measure of financial success. It looks at all debts and liabilities compared to all assets, land, machinery, etc. This is where farmers have benefited over the last 40 years. With land prices on a steady value increase since the early 1980s, land assets continue to appreciate, adding value to your assets. Anyone who has been farming any length of time would see the value of their land assets increasing and improving your solvency. Today’s high land price is tomorrow’s starting price.
Increases in solvency allow you the flexibility to leverage the land you have, to expand and deal with the uncertainties of farming. It gives you a cushion for the difficult times as well as the ability to take advantage of opportunities. This has also resulted in those that have more land being able to buy more land easier than the small farmers. The big get bigger. They have what is called, the economy of scale. This is when production gains efficiencies on a cost of production per unit through size. They maximize the efficiency of their inputs and machinery. Also, being larger and spread over a greater area, they are somewhat protected from weather risk, at least in terms of some catastrophic weather events.
The third measurement of financial success is profitability. This is the measurement of percent return on investment. For much of the last 50 years, farming has not been all that profitable. The gains in the industry have come in terms of land value. As the old saying goes, “They’re not making any more land”. Profitability is the net income divided by the total assets value. In agriculture, that is usually in the single digits. It also differs depending on the agricultural enterprises you have. Livestock tend to be fairly low on profitability compared to annual cropping. However, not all land is suitable for growing annual crops.
There are other ways to analyze a farm operation. If you have a mixed farm, you can analyze each individual operation to see where you are making money or losing it. However, that can change annually, depending on commodity prices. Take, for example, a cow-calf operation. This year, with very high feed costs, the hay operation may make money but feeding it to the cows is at a loss. This shouldn’t mean you get rid of the cows and sell the hay. Next year, the numbers will be different. However, you can look for changes to make the individual operations more efficient or effective.
Financial indicators are useful tools to determine if your farm operation is providing you with a living and acts as a good investment. Look at long term trends, not just one year, to determine the health of your operation and the direction it is heading. These are the same tools your banker uses when approving operating and land/machinery loans, so you should use them too. Achieve your long-term goals one step at a time, profitably.