The low-price, high-cost economic scenario of recent years has shrunk working capital on some farms and with it the ability to service critical financial needs such as interest expense and debt retirement, not to mention business growth and family living.
“We’ve lost 50% of farm income since 2013, yet direct costs have remained high,” says Charles Brown, farm management specialist with Iowa State University Extension and Outreach. “When commodity prices were high, farmers incurred a lot of capital expenses – for land and machinery. Those purchases worked out with good commodity prices. But with present low prices, the purchases no longer cash-flow. It’s really changed the nature of farming operations.”
Fixing the issues helps build financial resilience into a business despite low prices and high costs. Rebooting a business to operate in the black begins by ferreting out the biggest financial drains.
Restructuring debt over longer terms is an obvious way to reduce principal payments and, thus, free up cash. “You might even roll some loans into land debt,” says Brown. “You could reamortize that debt over a longer period of years to free up working capital.
“But restructuring the debt doesn’t solve the profitability problem,” he says. “It just buys you some time to fix the issues causing the lack of profitability.”
“A starting point is to figure the efficiency of the operation,” says Brown. “Using a spreadsheet or even your Schedule F tax records, figure the percentage of gross revenues that you convert into profits. Don’t include interest or depreciation in your costs. The percentage you calculate is the net efficiency of the farming operation. If that number is lower than 25% to 35%, then you typically won’t have enough profit to support interest expense, debt retirement, business growth, and family living.”
A low net efficiency points to one or both of two problems: Either the operation is not generating enough revenue or expenses are too high.
Analyze and question income streams and cost categories.
“Is poor production causing the problem? Or is it poor marketing? Are costs too high, say, for labor, rent,
or inputs?” Brown asks.
Take a look at interest costs and living expenses.
“As a rough guideline, the farm contribution for interest and living expenses should be no more than 60% of the profits,” says Brown. “That leaves 40% of the profits for debt reduction and business growth. Yet, I’ve seen operations paying 100% of their profit in interest and living expenses.” If, on the other hand, net efficiency is good – 25% or better – but the operation is still having trouble with cash flow, Brown suggests looking at debt load and structure.
“Cash flow could be tight because principal payments are too high, and restructuring debt over a longer term could reduce these,” says Brown. “If the debt is on land, consider that it usually takes another enterprise besides cropping for land purchases to cash-flow.”
4 Ways to Reboot
Analyze these four areas of your operation to find ways to reduce debt as well as operating costs, or to increase revenue:
1. Machinery investments.
In Iowa, these have increased from $250 an acre eight years ago to the present investment cost of $600 per acre, says Brown. “Part of that increase results from advancements in technology,” he says.
Evaluate your farming practices to see if changes could be made that would reduce the equipment inventory, freeing up machinery to sell. “Converting to no-till or strip-till, for instance, could reduce the equipment line,” says Brown.
Custom hiring some field operations eliminates the debt incurred by owning equipment, of course, as does leasing. Leasing has become more cost effective in recent years, says Brown, as dealers increasingly offer competitive lease rates.
On the other hand, providing custom-farming services using your existing equipment could increase revenue.
2. Land use.
“Do a crop-by-crop analysis to find which crops are most profitable on your operation,” he says.
The analysis could lead to brainstorming the potential production of specialty or alternative crops. “I have seen producers who have done well by growing hay, for instance,” says Brown. “The production cost is high for the first year, but inputs are minimal for the next four or five years, as long as you’re producing high-quality hay that you can sell for a reasonably high value.”
Renting fields to livestock producers for grazing could increase per-acre income.
Leasing land to hunters offers another option for income. “This varies by state, but here in Iowa, hunters are sometimes willing to pay $20 to $30 an acre to hunt deer or pheasants,” says Brown. “The overall idea is to think of other things you can do with the land beyond growing crops.”
3. Profits from individual fields or farms.
Analyzing net profits field by field can highlight problems with productivity of some land or costs that are too high. Letting the land go or finding ways to reduce costs are options. “Some farmers may be paying too much cash rent for certain pieces of land,” says Brown.
Base projected crop revenues on realistic conditions. “When predicting possible cash flow, calculate scenarios based on high-, mid-, and low-price ranges for crops,” says Brown. “Anticipate variable yields.”
4. Family living costs.
Tina Barrett, executive director of Nebraska Farm Business, says, “The average family participating in our program spends between $90,000 and $100,000 on family living. In 2004, the average family spent $40,000 to $60,000.”
The increased spending comes from higher prices of purchased goods and services, including health care. Yet, a higher standard of living contributes, too, to increasing outlays for family living.
In the end, putting all options on the table could show ways to craft an action plan that would reboot the operation financially. The creative course could lead to a resilient plan for refinancing.
“The most important thing is to spend less money than you make,” says Barrett. “Or you might have to look at supplementing farm income with off-farm income. You may have to do both: control costs as well as increase off-farm income.”
“Be proactive in your planning with lenders,” says Brown. “Always look for ways to improve the productivity of your operation so that you don’t have to face cash-flow shortages again three years down the road.”
A SHARING ECONOMY
As profit margins narrow, one way to reduce costs is for farmers to work with other farmers as a means of spreading machinery and overhead expenses across more acres.
“I’m seeing more incidences of collaboration between farmers,” says Danny Klinefelter, professor emeritus of agricultural economics at Texas A&M University. “Each farmer may have equipment for 2,000 acres but farms only 1,000 acres. They can all join forces to use equipment more efficiently. Maybe one farmer has more expertise in a certain area than the others,” says Klinefelter. “Collaboration lets people share labor by doing what each does best.”
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