The Profitability Triangle | Michigan Farm News

The Profitability Triangle

Category: Markets & Weather

by Paul Anderson | GreenStone Farm Credit Services, Executive Vice President/Chief Credit Officer

Profit-Triangle_MFN_1.11.19
Don’t go it alone. Consider establishing a formal or informal advisory board for your farm. Individuals such as veterinarians, agronomists, nutritionists and lenders can share learnings from others and provide advice based on experience with other farmers. Photo Credit | Farm Credit University

While a foundation has been set for long-term viability for leading commodities in Michigan with the announcements of increasing milk processing, the opening of a state-of-the-art hog processing facility and a national timber processor breaking ground, the short-term still appears challenging.

Looking out at the near-future commodity and world markets, we are not seeing any indicators suggesting much change in current market prices. Commodity inventories remain high while it appears major economic zones in Europe, China and developing markets are experiencing a slow-down in economic growth as measured by gross domestic product (GDP). These factors combined have the potential to keep commodity prices at their current levels for the next several years.

Given these indicators, farmers need to be prepared for another year of challenging commodity prices. Recognizing most farmers have already made cost reductions and changes to improve profitability, I offer the following management strategies based on my 25-plus years specializing on financial turn-around with farm operations.

Based on my experience, there are three legs to farm profitability: production execution, financial management (records) and marketing. In good financial times, farmers can show profitability by being exceptional in only one or two areas, such as increasing yields or production. However, in tight times like today, it is critical all three areas are equally balanced to provide a steady foundation.

Production efficiency is the area most farms manage well. Using technology and genetic advancements, our farmers are capturing yields and production levels unimaginable just a decade ago. Knowing the production costs per unit are often the missing pieces when we have discussions with many farmers struggling financially. Understanding your cost for what you produce is critical in this commodity price environment where every penny counts.

When looking at production costs, the focus should be on efficiency, not necessarily lowest cost. Farmers who know the incremental cost of production can more accurately make management decisions regarding the cost of additional inputs versus the value of the incremental increase in production or where costs can be shaved without impacting production and revenue.

We recently worked with a dairy farmer who, after carefully analyzing his costs (to the penny), was able to carefully shave $2 off his cost of production to a $14 level over several years without impacting revenues. One of the key decisions he made was to invest in a better management information system, tracking production and financial information needed to evaluate results, and then proactively make adjustments based on measured results.

Accurately determining the cost of production is achieved with quality records, accounting for all revenue and expenses on a regular basis. Records should reflect current activity as well as projected activity throughout the year. Accurate records become the foundation for developing projections for the upcoming year helping farmers look across the horizon to anticipate how the business will operate throughout the year.

We encourage all our customers to closely evaluate their business, establishing key production and financial goals that can be measured. If farmers are not comfortable computing these metrics, we encourage them to work with their lender, an accountant or other farm consultants to establish a plan that works for their business.

Armed with cost of production information based on quality records, farmers will be in a position to develop a written marketing plan. A marketing plan should incorporate available risk management tools like crop insurance and revenue protection programs as a hedge against not having sufficient crop to cover your marketing positions. Many farmers in the niche commodities are taking a closer look at the whole farm revenue insurance product.

A written marketing plan is of limited value if you don’t follow it. I was told early in my career that “you can’t go broke taking profit opportunities that the markets present, but you can go broke being greedy.” Those farmers who are successful in long-term marketing exhibit the discipline to make a plan and then execute it.

If after maximizing these three areas the farm is still struggling to gain profitability, identify assets that are not being efficiently utilized and could be sold to reduce debt, improve profitability and cash flow. In all cases, consult with your tax professional to understand the income tax ramifications of any asset sale.

One area of efficiency evaluation that is often overlooked is family labor draws from the farm business. Can the farm support the existing family units? Farmers in Michigan and Wisconsin have an added advantage of a strong job market and opportunity for non-farm income to diversify revenue sources. We are seeing more farmers or their family members increasing the level of non-farm income through partial or full-time employment off the farm.

Don’t go it alone

One of the best practices we see implemented is the establishment of formal or informal advisory boards for a farm business. These groups include those vendors and business associates with a vested interest in the farm’s success. Individuals such as veterinarians, agronomists, nutritionists and lenders can share learnings from others and provide advice based on experience with other farmers.

At GreenStone, we provide peer-based benchmarking analytics for our greenhouse, row crop and dairy customers presenting the range of measurements in key financial metrics. Farmers interested in participating in the peer-based reporting can work with a GreenStone representative to have their information included.

Most importantly, we encourage customers to keep open communication with those they work with, including their lender. We are continually working with customers to take proactive measures to help the farm reach its long-term goals. Together, we will design plans to achieve a mutually agreed-upon plan.