All businesses are headed somewhere financially.
Past performance is an ex-cellent indicator of what the financial future for a farm will look like, but what about the future? How can we analyze future performance?
Farmers make management and ownership decisions all the time about operations, investment and financing. Are these decisions getting farmers’ financial performance to where they need it to be and want it to be?
Setting financial targets helps answer these questions by creating context that is relative to the impact the various decisions will have on desired financial outcomes.
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Without the targets, it is difficult to assess the impact of changes in financial performance that may result from a variety of different operations and investment and financial scenarios.
Targets can be used as performance measures that farmers can strive to achieve. For example, they can set a high threshold target and see if it can be reached.
The targets can also be measures that farmers strive to not fall below. For example, they can set a low threshold target and make sure decisions don’t cause performance to fall below it.
Some farms will set lower value targets that are in line with lending covenants. Setting targets at these values help farms know when their decisions may be taking them to financial performance levels that are contrary to what was agreed to in the covenants.
Targets are set individually for each ratio or financial indicator. They should ideally be set for all ratios or indicators, but farmers are not required to have a target for each ratio. It’s a good idea to include at least one ratio or indicator from each of the liquidity, solvency, profitability and financial efficiency categories.
If I was going to track only six ratios, I would set targets for working capital percentage, equity, debt to equity, debt servicing, gross margin and net operating profit margin.
The ratios generally include “good,” “average” and “poor” performance classifications.
Farms in different situations will experience different performance at different stages in their business and personal life cycle. As a result, they should set appropriate targets with the business and personal life cycles in mind.
For example, a farmer who is nearing retirement may have less debt and therefore a low debt servicing ratio, which would mean they would be in the “good” or acceptable classification.
However, the debt servicing ratio would increase if they needed to borrow money as part of an expansion or succession plan, which could possibly mean that the performance would be in the “average” classification.
The target that this farm would set for debt servicing performance would likely be a reflection of the farmers nearing retirement and would be a more moderate target than perhaps a younger farmer who was in growth mode.
Farms are generally larger and more complex, which means they require more investment and often more debt.
Farms often have people with a shareholder or stakeholder interest or investment in the business but who are not actively involved in day-to-day management. They want to protect their investment and get a fair return on it.
One way to bridge the discussion between active and non-active shareholders is to be able to test performance against agreed upon targets. I’ve worked with farm families who have successfully done this by setting targets and using them as a basis for analyzing the farm’s financial performance at their annual meetings.
As well, agreeing on financial performance targets can potentially help avoid conflict that may stem from poor financial results.
There are obviously no guaranteed outcomes in farming. Decisions are made with the best intentions in mind, but situations can occur where the financial results are not good, which can be stressful. It can help if everyone was as clear as they could be on the potential impact of a decision.
I’ve not come across any farm family that didn’t think it makes sense to have financial targets.
However, I’ve also not run across many who have a full set of targets in place. I believe that this is going to become more of a standard practice in the future.
