It’s bound to happen. Past experience indicates that it always has and likely always will. It’s only a matter of time.
When Issac Newton defined his third law of physics, the law of motion, being what goes up, must come down, I don’t think he was talking about grain and oilseed prices.
It is applicable, however. Up went prices, way up, and at some point, they will turn and come back down. If we only knew when, and if we only knew to what level they would fall back.
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One thing we know from the past price spikes is that, generally, the new post-spike bottom-end price range has been at values that have been higher than the range before pricing spiked. Another thing we know from past experience is that the price spike has been relatively short-lived.
Clearly oversimplifying things, when the price spike occurs, everything else goes up, albeit with a certain lag factor. Capital asset prices increase. Given that most of the capital purchases will have been financed, the resulting increase in debt levels correlates with higher risk.
Operating costs in general increase as well, notably production costs but also costs like land rent. When the grain prices retract, costs historically have not retracted to pre-existing levels. Again, enduring higher costs of production and lower grain prices result in higher risk.
This is nothing new, although it’s different this time. One of the arguments about it being different has to do with interest rates. We don’t know how high they’ll go or how long they’ll remain high. Hopefully Newton’s law of motion applies here as well and as quickly as possible.
Another argument has to do with inflation rates. Typically, the farm economy does not track perfectly parallel to the general economy, meaning that higher inflation rates in the general economy do not necessarily translate to higher inflation rates on the farm.
The reality, though, is that inflation at this time is very real on the farm. At a meeting I attended last week, an informed individual commented that companies are widening margins simply because they can and at rates not justified by their increasing costs of doing business. This is getting passed on to the farmer.
So, what can farmers do, considering what’s going on and all the associated uncertainty?
I have some observations.
Firstly, business management practices on the farm have always mattered. They just haven’t always been the primary focus, beyond operations, that is. For a long time, being a good farmer with average to above average yields were enough to sustain the farm business.
I think this has changed, some time ago actually, but I don’t think that it has hit home for most farms. The day of reckoning on the other side of the “turn” may be fast approaching.
In the past 15 years, there have been two periods where many farms were right at the edge of financial uncertainty, where margins were essentially non-existent and with hope for a turn-around dismal.
Then along came an unexpected price spike that solved a lot of problems but it also masked a lot of management deficiencies.
The second observation I have is about financial performance. There are two extremely important financial efficiency ratios that should be calculated and understood on the farm. They apply directly to management focus.
The first is the gross margin. It is the margin of profit remaining after you subtract your direct production expenses from sales (revenue). Some farms sustain a higher gross margin than others. Data over 10 years suggests a range from the top to the average, in percentage terms, of about 15 percent, depending on the year.
The second is the overall operating efficiency margin. This is the margin of profit after all expenses required to operate the farm have been subtracted from revenue, except for interest costs and depreciation (amortization), that is. Obviously, there will be less margin after all costs have been accounted for. Again, there is a range from the margins reported by the top operating efficiency margin farms and the average.
There are generally accepted industry performance standards for the margin. Top operating efficiency margin farms are able to sustain performance at or above the standards over time. But there is a concerning gap between those farms and the average.
The data suggests that the average farmer is becoming increasingly less operationally efficient. Worse yet, and I think worrisome, is that the gap is widening.
For many farms, I think the weakening operating efficiency metrics are indicative of less attention to overall business management practices.
On the other side of the “turn,” farms with weak operating efficiency may not be able to farm their way out of trouble.
A key differentiating factor from farms reporting higher operating efficiency and those with lower efficiency has to be management.
Applying a focus on superior farm business management practices will help in managing the “turn.” I understand that this is easily said but not easily done.
Start by calculating your operating efficiency margins for the past five years and examine the trend. If you don’t know how to do this or don’t have the time, find someone to help. It might be a game changer.
Terry Betker, PAg, is a farm management consultant based in Winnipeg. He can be reached at 204-782-8200 or terry.betker@backswath.com.
