Producers warned to get their costs in line

A financial adviser says farmers must learn to adjust to the leaner times ahead, particularly how to handle cash

Only when the tide goes out do you discover who has been swimming naked, said Shannon Lueke, quoting Warren Buffett.

That scenario applies to farming today, which after a decade of good years has seen markets tumble and total costs per acre increase.

“There is no hiding place when growing conditions, market prices and interest rates all start heading in the wrong direction — all at the same time,” said the farm management consultant and agrologist with MNP during Connect: The Heart of the Farm conference in Saskatoon Nov. 6-8.

Women in Ag organized this year’s conference.

Lueke said management mistakes and over-spending issues can be papered over by years of good harvests. She said many farmers equate number of bushels with prosperity, regardless of quality.

But now as the farming economy turns downward, profits are getting smaller, or have disappeared completely and costs are increasing.

On the positive side, she said lack of interest rate increases and a crop that is now mostly in the bin despite a poor growing season are two bright spots.

“I always say more bushels, less quality is better than no bushels at all,” she said.

But she said many farmers must learn to adjust to the leaner times ahead. She said this could be a problem for many farmers because those who never had decent cash flow generally do not know how to handle cash.

“If they have never had it, they will likely continue to not have it, regardless of what their profit is. They have a tendency to waste it away on stuff,” she said.

Unlike other businesses that have to carry a certain amount of cash to meet their obligations, such as payroll, farming can borrow against long-term assets. That has resulted in distorted perceptions of profitability based on the ability to borrow.

“Hence the debt measures have generally not improved in recent years. The more you make, the more you spend, and the more you borrow,” she said.

As far as a farm’s profitability, she said it’s not as straight forward as growing more bushels per acre.

She said it’s common knowledge that not all land has the same gross revenue potential. Even within the same region producers must manage costs according to the land they farm.

But many farmers do not properly manage their overhead costs, despite their differences in land quality and earning potential.

Before seed is planted, it’s important to determine realistic potential gross revenue per acre, she said.

“The reason you figure out the profit margin before you go seeding is so that you know how much room you have on your gross revenue (of production)….

“So when you’re done harvesting, do you know if you can only lose 10 percent, 20 percent, or if you’re already behind before you even start seeding?” she said.

For example, a farmer who has a potential of $480 per acre is going to manage that differently than someone at $380 per acre.

But during the last decade, some producers stopped managing costs based on their revenue potential. Emotional decision making surrounding many factors, including new equipment purchases and higher land rental charges, are clouding decisions and affecting producers’ bottom lines.

“It’s measuring yourself against your neighbor and not yourself. It’s not understanding what you can afford to pay and what you can’t afford to pay,” she said.

This has led to a situation in which many farmers on marginal land assume similar costs to farmers on higher quality land.

“We believe that a farmer should be able to manage his or her cost structure to allow for 10 to 20 percent profit margin on their plan, regardless of the land they farm. This allows for some room for downturn should conditions change,” she said.

MNP has developed a cost structure — a template that starts with 100 percent revenue:

  • less: productions costs (should not exceed 40 percent of revenue)
  • less: labour, power and machinery costs (should not exceed 32 percent of revenue)
  • less: land, building and finance costs (should not exceed 12 percent of revenue)

With this example, the bottom line profit equals 16 percent of revenue.

She said every farm should be able to line up these three categories of costs in their businesses so there is the potential for 10 to 20 percent profit margin.

“If not, then knowing which cost centre is out of line enables management to hone in on the problem area, work through a solution and then get that potential margin back in line,” she said.

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