I would be in the group that believes that you shouldn’t try to manage by looking in the rear-view mirror. Farming is next year country. There is a lot about “next year” that we can, though, understand by examining past performance.
We all have things that we would like to have had a second chance at. There’s a saying that you can’t make the same mistake twice because the second time you make it, it’s not a mistake, it’s a choice. The implication is that we should learn from experience, improving on things that could have turned out for the better.
But what if we were unaware of what really happened in the past and as a result, were not able to apply that learning to future-based decisions. In farming, those future-based decisions are all about “next year.”
Financial outcomes, as measured by profit, apply. How much profit were you able to generate on your farm last year and then for the past five years? This will assist you in looking at trends. You can also look at the average of the past five years and compare it to last year, or the last two years if you’ve just come through a couple of disappointing years. What do the results tell you? Are you happy with the performance?
For many farms, the answer would be not really. It’s been tough due to a combination of weather, low commodity prices and global impacts on market access.
Understanding how much money is or isn’t being made, or profit, is always important. Human nature tends to be a factor though, when profit and cash flow are strong. There may not be the urgency to take a critical look at the business and see what adjustments could be made to increase profit. This all changes as profit margins narrow and cash flow tightens.
I’m going to focus on two aspects of analyzing profit on a farm. First is the timing of understanding past performance, most recently for 2019.
This is a function of when you receive your financial statements, if they are being developed by an accountant, or when you complete them, if you’re doing them yourself. They should be completed as soon as possible after your year-end. Farms are starting to make decisions on the next year earlier and earlier. It’s quite likely that some decisions will have been made already that will impact 2021. If your financial statements are coming from an accountant and you aren’t receiving them as quickly as you’d like, ask what you would have to do, or provide, so that the statements would be ready sooner.
Depending on the complexity of the business, statements can be ready in just a few weeks from the year-end. Accountants are extremely busy. The key is to provide them with information that is as clear as possible. It may take a couple of years to fine-tune your financial administration processes, but improvements can be made, resulting in statements received sooner. The sooner you get your financial statements, the sooner you can look at things that worked well or at areas that could be improved upon.
Second is the organization of your income statement. Income statements, in a set of financial statements from an accountant, will be put together and published according to generally accepted accounting principles. I continue to see income statements developed for farmers, while technically correct (according to GAAP), that do not present financial information in the most helpful way from a management perspective. What can be done differently? Let’s look at revenue.
Revenue minus expenses equals net income, or profit. But what comprises the revenue? Income statements should be organized so profit margins can be easily calculated, including how core and non-core revenue is separated.
You need to look at the margin of profit generated by your business from core operations. Core operations are defined as being the main purpose of the business. Examples of non-core revenue include:
- patronage dividends
- incidental custom work
- purchases or sales of breeding livestock
- gains or losses from the sale of equipment and buildings
- government programs like Agri-Stability
- surface leases
The most important point is to first analyze where profit is coming from. Is it coming from core operations or is there a substantial amount of non-core revenue?
I’ve seen farms where their financial statements reported a profit but in reality, the farm was losing money. The non-core revenue was painting an inaccurate picture. It can be a real problem when the farmer isn’t aware that this is happening. The income statements should be structured so that margins of profit separate core and non-core revenue.
This takes me back to understanding past financial performance and using that information to identify adjustments that can be made to achieve optimum margins of profit so the same mistakes aren’t made again and again.
Are you working from good and timely information? Do you know the margin of profit that came from core operations? Are you applying the knowledge to decisions going forward?