Have you given your business its annual exam? If not, now is the time to do it. You should already have your tax records from last year, hog prices have climbed back to profitable levels and crops are planted.
“Just like a person’s annual checkup, businesses can be healthy and unhealthy,” says Alan Miller, farm business management specialist, Purdue University. “If you know your farm is profitable, it makes you feel more comfortable about your long-term position in the industry.”
Instead of guessing about your operation's profitability, you need to find out how the numbers add up. And operation size is irrelevant, notes Miller. When hog prices hit rock bottom in 1998, producers running all sizes operations felt the pinch.
The first step in your profitability search is to learn more about benchmarking. Miller suggests looking at the returns on stocks and certificates of deposits as examples. You need to be earning returns on your total capital investments that are at least 2-3 percent above the going rate for longer term CDs and preferably should be targeting the 10 percent to 12 percent long-term average returns associated with common stock ownership. Returns on your own equity capital (net worth) need to average even higher.
Then look at the pork industry. Miller recommends finding other pork producers – those that are doing well, to compare how you are doing. If you're not at the profitability level that you want to be, then you need to get a clearer picture of where you stand.
Granted, some operations may be more modern or are managed differently than yours, but this analysis is a good place to start. The National Pork Producers Council is developing a database that may provide you with some of this information.
To assess your financial situation, Miller and his ag economist colleagues at Purdue recommend starting with a brief financial description that includes:
1. Total assets: The market value of all your financial and capital resources.
2. Total liabilities: The value of your total debt obligations, including bank loans and suppliers.
3. Owner equity: This is your financial stake in the operation. You get this
figure by subtracting your total liabilities from the total assets. This is your net worth.
4. Gross revenues: This measures the total value of the products, such as pork, corn, soybeans, that your operation produces. To accurately determine this amount, it's best to define this on an accrual-adjusted basis.
5. Total expenses: These of course are your total fixed and variable expenses that you incur during the year. Total expenses indicate the costs of producing your gross revenues.
6. Net farm income: This is the amount of income left after you deduct fixed and variable expenses. It’s a basic profitability measure.
For independent producers, this figure represents the amount of income you have available for such things as family living, income taxes and capital investments.
You can use this type of analysis to determine some bigger questions than, “Am I making a profit?”, explains Miller.
By reviewing these kinds of elements in detail, you are better prepared to look to the future, and to ask yourself honest questions such as:
- What does it cost me to produce pork?
- Am I a low-cost producer?
- Is my invested capital earning an acceptable return?
- What are the strengths and weaknesses of my current business?
- How can I build on the strengths of my business?
- Should I stay in this business?
- What types of changes will have the greatest impact on my financial performance?
A Web site providing links to benchmark data from selected farm business associations is available at www.agecon.purdue.edu/extensio/finance. You also can contact your state extension specialist or the NPPC for other benchmarking options.
Making the commitment to give your operation a financial checkup this year will provide insight.But by continuing these kinds of regular exams you can uncover even more useful knowledge about trends in your business.
Assessing Your Financial Strength
Do you have what it takes to go the distance? From a financial standpoint, your operation needs to perform better than the average of farms similar to your own, says a Purdue University team of agricultural economists.
The average benchmark provides you with a reference point to recognize better-than-average performance. However, that level probably won’t be high enough for long-term financial stability. Your business is likely in sound financial condition if it meets the challenges outlined below.
Your values are larger than the Benchmark for:
- Return on assets
- Return on equity
- Operating profit margin
- Current ratio
- Asset turnover ratio
- Revenue per full-time person
- Net farm income ratio
Your values are smaller than the benchmark for:
- Debt-to-asset ratio
- Operating expense ratio
- Depreciation expense ratio
- Interest expense ratio
Source: Purdue University, Department of Agricultural Economics.