It’s probably wise to tread carefully when talking about wealth and agriculture, considering weather challenges and fluctuating pricing for crops and livestock.
However, in spite of the challenges, many farmers have accumulated significant wealth over the years.
By assessing the source of this wealth, producers can make better decisions about their business, particularly decisions about investment and debt.
It can help to categorize the wealth as either earned or circumstantial.
Your wealth can come from a gradual accumulation of profits over time, which is called earned wealth, but it can also be generated as a result of a special event or period. In other words, a circumstance that generates profit.
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Wealth is generally expressed as equity in the business. In simple terms, equity is the difference between the assets you own and your debt. In other words, it’s your net worth.
The concept of earned wealth is straight forward. It is directly related to net profit.
You go about your business and the difference between your revenue and your costs, including the money you take out personally and for taxes, builds up over time as earned wealth in your farm business.
Circumstantial wealth is attributable to some thing or some event that has happened within the industry or within your farm business. The circumstance results in increasing your wealth. The key consideration here is that the circumstance can be related to earned and/or unearned revenue.
Lots of farms have accumulated
significant wealth due to actual earnings. The problem is that the earnings may have happened many years ago.
For example, there are farms that enjoyed a sustained period of tremendous profit in the 1970s. Since that time, they have been unable to replicate the circumstance for a sustained period.
The question is whether the circumstance is likely to be repeated.
If so, then you must ask if the farm business is properly positioned to best capitalize on the circumstance because it may not be repeated in a long time. If there is little confidence in the circumstance being repeated, how does that affect the business and how will that affect investment decisions and debt?
The challenge is to determine how long you think the current circumstance will continue and then, even more challenging, what will happen after it changes? Making longer-term decisions on the belief that the current circumstance will exist in the medium to longer term can be risky.
Other considerations to circumstantial wealth relate to factors other than earnings, such as capital appreciation on land and the value of quota in the supply managed sector.
It depends on where you farm, but generally there has been a significant increase in the value of land over the years. This has resulted in a large increase in wealth in farm businesses. This creation of wealth is unearned and not attributed to earnings.
The same questions apply. What is the likelihood that this circumstance will continue and how does that affect management decisions on your farm involving investment and debt? Can that wealth be crystallized?
There are scenarios where circumstances lower wealth, such as BSE in the cattle business. That circumstance resulted in a deterioration of wealth, both from an earnings perspective and, for a lot of farms and ranches, a reduction in asset value and net worth. What is the likelihood of something similar happening?
Farmers should examine their businesses and apply the test of earned and circumstantial wealth.
If your farm has accrued significant wealth, where did it come from? Will it continue to happen? Will it happen again? What will you, or can you, do about it?
By examining your situation, you can use that information to help you make better business management decisions, especially those related to investment and debt.
Terry Betker is a farm management consultant based in Winnipeg. He can be reached at 204.782.8200 or terry. betker@backswath.com.
