With the ever increasing cost of new and used farm machinery, it may pay for farmers to enter into joint ownership of certain farm machinery.  Probably the best type of machinery to have in joint ownership would be combines, sprayers and drills.  This type of equipment is usually only used at certain times of the year unlike tractors and trucks which can be used year round and would be more difficult to own and operate jointly.

The Iowa State University Extension Department has a very good article on how to structure these joint operations.  Even if the ownership percentages are different from the acres that are farmed, the accounting for these differences can be done effeciently and timely.

For example, in the case of combine joint ownership, I believe that you should perform an analysis of the total number of hours that a combine should operate each year to get the best rate of fixed cost amortization.  If you determine that this number is about 300 hours and you can average 10 acres per hour, this would result in the optimum acres of 3,000.  You would try to find another partner or partners to get a total of 3,000 acres.  This would allow you to minimize your fixed costs in operating a combine. 

If you farmed 1,000 acres of beans and corn and owned a combine costing $150,000 for five years and then sold it for $50,000 after the five years, you cost of ownership of this machine is $20,000 per year.  If you can find another farmer that has 2,000 acres, you would reduce your annual ownership cost from $20,000 by 2/3 to $6,667 or a savings over five years of about $67,000.  Also, the other farmer may be able to provide additional services such as repair experience, trucks, dump out wagons, etc. that you do not have now.

Other factors need to be reviewed such as how close and compatible your farm partner(s) are.  The age of the machinery, the amount of other equipment to support the jointly-owned machinery and who would operate and maintain the equipment.

A Senate Subcommitee spent the past year investigating the impact of index funds on the wheat market.  They concluded that all of this new money flooding into index funds distorted the market.  The 247 page report released on June 24, 2009 summarized their findings as follows:

1.  Excessive speculation in wheat.

• Index Traders increased future prices relative to cash prices.  The large number of wheat futures contracts was a major contributing factor in the increasing difference between futures and cash prices between 2006 and 2008.  Largely as a result of index trading, the basis difference between cash and futures rose from 13 cents per bushel in 2004, to 34 cents in 2006, 60 cents in 2007 and $1.53 in 2008, an approximate 10 fold increase in four years.
• Index traders impeded price convergence at expiration.  Normally the futures price and cash price should converge to an approximate difference of zero at expriration.  The index traders created a frequent failure of the markets to converge.

2.  Inflated futures prices affect crop insurance.  Because federal crop insurance, which is backed by taxpayers dollars, use futures prices in its calculations, inflated futures prices can inflate insurance premiums, whose costs is shared by farmers and taxpayers, and impair the accuracy of the formulas used to determine the payouts to farmers, resulting in either overpayments or underpayments.

3.  CFTC waivers facilitated excessive speculation.  The report indicated that certain funds were allowed to have up to 53,000 contracts at a time.  This represents about 265 million bushels of wheat which would equate to over 10% of the total US crop.  Six funds are allowed to hold up to 130,000 contracts equalling 650 million bushels.

4.  Poor data impedes analysis. 

The report found four recommendations:

1.  Phase out existing wheat waivers for indes traders.

2.  Take further action if necessary.

3.  Analyze other agriculural commodities.

4.  Strengthen data collection for non-agriculatural commidities.

My opinion on these findings is that it is easy to blame these index funds for causing the excessive speculation in wheat prices, however, they do not really address whether this is actually a bad thing. 

The crop insurance issue can be addressed by changing from future prices to various cash markets around the country. 

Also, these index funds do provide liquidity in the market that would not otherwise be there.  I also believe that a lot of elevators were hedging their purchases using futures and the diveregence of the futures to cash prices probably did have a huge effect on them.

You can read the 21 page executive summary of the report.

For several years, farmers who grew organic crops were able to generate higher returns than non-organic farmers.  However, with the current recession, those days may be coming to an end.

Organic farmers are required to meet tough standards to have their crops and food products branded as organic.  Generally, they are not able to use any commercial fertilizers or pesticides and in the cash of milk or animals, all of the feed that is used in the operation must be also organic.

For many years, the demand by discerning consumers for organic food created a premium pricing for these growers and farmers.  I know many farmers were able to get a two or three times premium for their organic products over comparable non-organic products.  Any time that you have this type of pricing differences, two things can happen that will negatively affect the price.  Either demand can decrease or supply can increase.

For most organic farmers in today’s environment, both things are happening.  The recession has decreased the demand for these products due to the large differences in prices.  The old consumer that might have been willing to buy a gallon of organic milk for $6 or more would rather buy non-organic for $3 or less now.

Also, many new farmers are coming on-line with organic products.  This is causing there to be a large increase in supply along with an offsetting decrease in demand will cause many organic food product pricing to diminish rapidly.  Also, many of the input costs for organic farmers are continuing to increase while their prices drop.

For example, organic dairy farmers have probably seen their price for their product drop by almost 50% over the last year or so, while the cost of buying a bushel of organic corn to feed their cows is still around $10, which over twice what a conventional dairy would pay for corn.

If you are thinking about changing over to organic farming in the near future, please make sure to determine how these factors will effect your operations.

Fortune magazine just had a interesting article on farmland being a great investment, both in today’s environment over the last 5o years.  Part of the article was about investing in US farmland and part was about investing in farmland internationally.

I think the themes in the article hold true.  We will always need to eat and they really are not making any more farmland (we may be converting some, but we probably lose more to urban growth than we convert).

I think over the next generation, farmland will continue to do at least as well as other mainstream investments. 

My biggest concern is that certain hedge funds may start to invest in farmland and drive up the price to create a bubble.  This can distort the real return and cost farmers money in the short term.  The article mentioned an annual rate of return of 13% to 16%.  I think for a short time period this may be true, but over a longer period of time I think it may be tough to get much more than 10% to 12%, but this is still better than inflation and you can enjoy more than a share of stock or bond.

My other concern that normally when farmland is on the cover of a magazine like Fortune that we are usually at the top of the investment cycle for farmland at that time.  We shall see.

As a CPA, I review a lot of financial statements.  As part of this review, I try to determine the ratios that separate the business from other businesses in the same industry.  Sometimes these ratios are positive and sometimes they are negative.  For comparing ratios for farmers, a great site is the Farm Financial Database.  This site has income and expense data for almost all types of farms in about 10 states around the country.  You can compare the net income for corn farmers in 1993 to 2008 sorting by the bottom 20%, the next 20% and so on.

I took the data for 2008 for Minnesota, Nebraska and Missouri and did this exact analysis.  From this, we can determine what is the difference between so-so farmers and great farmers.  The highlights are as follows:

  •  Great farmers yield about 20 bushels per acre more than so-so farmers.  They also sell this crop for about 60 cents per bushel more than the bottom farmers.  This results in extra gross revenue of about $180 per acre.

  •  Great farmers spend a lot less on chemicals and fertilizer than so-so farmers.  For 2008, they spent about $123 per acre versus $160 per acre for the so-so farmers.  They do this while still producing 20 bushels per acre of more corn.  Remember, these are per acre costs, not per bushel costs.  Have you reviewed your chemicals and fertilizer costs to see how it compares to these great farmers.

  •  Great farmers minimize their repair costs.  They spend on average about 50% less on repairs than s0-so farmers.  Are you doing every thing you can to minimize these costs.  Is your equipment updated and maintained in the off season.  Do you higher out everything when something goes wrong.  I remember growing up on the farm that my dad was able to fix almost anything that went wrong with the farm equipment. 

  •  So-so farmers spend about twice as much on custom hire as great farmers.  It is only about an extra $6 per acre, but it adds up.

  •  Most of you would think that great farmers spend more on cash rent since they probably have better land.  The reality is that all farmers spend almost that same amount on cash rent per acre.  It ranged from $132 for the so-so farmers to $123 for mid-range farmers.  This indicates to me that great farmers farm the same land as anybody else or spend their time picking the best land to rent.

  •  So-so farmers spend the most on operating interest at about $15 per acre compared to about $10 per acre for great farmers.  This makes sense since they are spending more money on operating costs than the great farmers are.

  •  So-so farmers spend twice a much on hired labor per acre than great farmers.  This costs them about an extra $5 per acre.  They also incur an extra $10 of machinery and building depreciation.  These two ratios indicate to me that they are not getting their maximum return from labor and machinery.  How does your stack up.

  •  Finally, great farmers actually allocate more cost to their land for their time and effort.  This costs them about an extra $5-10 compared to so-so farmers, but it certainly appears that they are well worth it.

After you add up all of these differences, the bottom line per acre income for so-so farmers is about $62 in the hole for 2008.  Great farmers earned about $265 per acre.  This ends up being a $327 difference per acre.  On a 1,000 acre farm, this is about $327,000.

It is well worth your time to compare your farm operation to the great farmers and see how you can get great.

As a CPA, I get asked many times by small business owners what their business is worth.  As part of calculating that value we usually work up what the net bottom line earnings of the business is.  To detemine that, we take the profit and loss of the company and make certain adjustments.  Normally, we add back interest paid, depreciation and amortization and other one-time items.

From this number, we then make various deductions, of which, usually the major one is the deduction for compensating the owner for their time and effort in running the business.  In some cases, we actually need to add back an amount since the owner has taken out to much compensation, but in most cases, we need to deduct owner’s compensation.

In many cases, after deducting a fair amount for the value of the services provided by the owner to the business, we can end up with negative income.  When this happens, we usually tell the client that they do not have a valuable business, but rather a job.  It may be a well paying job, but for business valuation purposes, it is just a job.

For farmers, in arriving at the bottom line profit of the business, many do not deduct a fair value for their services provided to the farm.  You need to do this in order to detemine if the farm is profitable and by how much.  Many farm decisions are made based upon erroneous data and this mistake can be huge.

For example, the Center for Farm Financial Management provides an excellent database of what various farm operations are earning per year since 1993.  In all cases, these farm returns include an allocation for labor and management charge for the owners.  For corn production, this charge was in the $30 to $40 range per acre and for soybeans, it was about $10 per acre lower.  If you do not make this allocation, then you will think your farm was more profitable than it actually was.

For either very large or very small farms, this allocation could be distorted.  If the farm is very large, but managed very efficiently, then the charge per acre may be smaller.  If the farm is only 500 acres and the farmer is working it full time, then this charge could easily be $100 per acre or greater. 

You need to review this closely to see how profitable you really are.

The people behind Successful Farming have developed a network for new farmers called Farmers for the Future.  They have had at least one conference and Loren Kruse, Editor-in-Chief of Successful Farming recapped the key ideas from the last conference.

This recap had many good ideas for new farmers, but I think almost all of the ten themes listed apply to all farmers.

The themes were as follows:

• Follow up your dreams with a written plan
• Look for other opportunities
• Build an attitude for success
• Hone your people skills
• Make your farm as special as a s business
• Know your strengths
• Build your reputation for things that matter
• Try new things
• Balance family and farming
• Help others grow

The three themes that really stood out to me were:

Follow up your dreams with a written plan- I am a firm believer in writing what you want to accomplish.  It does not need to be fancy, but write down on paper (or type it, etc.) what your goals are for the farm.  Make sure to list both business, i.e. how many acres I want to farm, what types of crops, etc. and personal, i.e. do you want your spouse and children involved, etc.  Although I have not seen a study, it is my firm opinion that a study would show that a written plan is achieved much more than a verbal plan.  If it is in writing, your spouse, banker, marketing advisor, attorneys, will all be happier.  WRITE IT DOWN.

Know your strengths- I think too many people spend too much timing on correctly their weaknesses and not enough time on expanding and promoting their strengths.  By the time you are out of high school (I would say kindergarten for most people), your traits are pretty well set for life.  Why get frustrated on trying to fix weaknesses that are very hard if not impossible to change, while you could be enjoying enhancing what you do well.  You can always find other people or advisors to do what you do not do well.  PROMOTE YOUR STRENGTHS.

Build an attitude for success – Attitude can be more important than perceived reality.  If you think you will be a success, it will be much easier than if you think you will be a failure.   Surround yourself with others that believe in you and your farm, continue to read and learn.  These steps will build a stable platform for farm success (and life success).  BUILD A SUCCESSFUL ATTITUDE.

In a recent article in the Regional Economic Development publication of the Federal Reserve of St. Louis, the three primary phases of the U. S. Corn Ethanol industry were documented.

These primary phases are:

• Birth – the events surrounding the oil shocks of the 1970′s from the OPEC price increases
• Development – The decline in fuel prices in 1980′s and 1990′s allowed the ethanol industry to get more efficient
• Mature – During the early 2000′s, the industry became more mature due to certain economic changes and political initiatives

This is a fairly long article with a lot of economic jargon, but it does a good job of describing where the ethanol industry has been and where it might be going.  It also does a good job of reducing the rhetoric regarding the large increases in corn prices being only a function of the ethanol industry.

One interesting chart is on page 14 of the publication.  This chart shows the pricing of corn in North Central Iowa from 1970 to 2008.  I would hazard a guess that the general public believes that last year’s corn prices were an all time high by a wide margin.  However, in the chart, using constant inflation adjusted numbers, the corn prices during the mid 1970′s were in fact close to $11 per bushel compared to the approximate peak of $7 in 2008.

The Federal Reserve Bank of Chicago reported that for their district (Illinois, Indiana, Iowa, Michigan and Wisconsin) farm land values dropped 6% from the previous quarter (the largest drop for a quarter since 1985).  Also, the year-over-year increase in farmland values was up only 2% for the first quarter of 2009.  The drop ranged from 3% in Indiana to 7% for Iowa and Wisconsin.  Some parts of Iowa were down 12% for the quarter.

Increases in cash rental rates also slowed to an annual increase of 7%.  However, with the drop in commodity prices and the continued high input costs, this should continue to squeeze farmer’s margins.  State increases for cash rents were 8% for Illinois, 6% for Indiana, 8% for Iowa and 2% for Wisconsin, while Michigan’s cash rental rates declined for the year.

The increase in cash rental rates has outpaced the increase in land values.  This results in the price-to-earnings (P/E) ratio for farmland continuing to decrease.   This index (with 1981 equaling 1.0) has ranged from a low of about .75 in the mid-80′s to over 1.4 in about 2006.  The index currently stands at 1.25 compared to 1981.  A good rule of thumb is as this ratio gets too high, then farm land values are probably overstated.  As this ratio gets too low, then the opposite it true.

For the District, cash rental arrangements continue to be the large majority of leases.  For the quarter, cash rental arrangements were used 80%, crop-share were used 16%.  Cash crop rentals ranged from 68% in Illinois to 97% in Wisconsin.

As of April 1, District interest rates had reached an all-time low of 6.20% for new operating loans and 6.14% for farm real estate loans.  However, with the recent spike in 10-year Treasury Bond rates, it is my estimate that these rates may be materially higher for the second quarter (it would not surprise me that they are close to 1% higher).

Looking Forward – About 30% of the bankers polled expect farmland values to continue to drop, while the remainder expect the values to remain about the same.  This same ratio applied to expectations for new farm loans for real estate.

If you are a farm landlord, you can be subject to several income tax rates and rules.  In general, you will either file your income on Schedule E, Schedule F or Form 4835.  Which onewill depend on whether you materially participate in the farm operation – in other words, the extent to which the landlord is involved in the operation of the farm.

A landlord receiving only cash rent will normally report their income on Schedule E and it will not be subject to self-employment tax. 

A share-rent landlord, who meets the tests for material participation will normally file Schedule F and be subject to self-employment tax.

If the share-rent landlord is not materially participating in the farm operation, they will normally file form 4835 and not be subject to self-employment tax.

Ohio State University has prepared a very synopsis on how these three types of rents are taxed. 

Since most farm landlords are usually retired, it is to your benefit to try to have the income taxed either on Schedule E (cash rent) or form 4835 (share-crop with out material participation)  If you do have a share-crop arrangement and wish to not pay self-employment tax, you need to make sure that you fail TWO of the following FOUR tests:

1. Advance, pay, or stand good for at least half of the direct costs of producing the crop.
2. Furnish at least half of the tools, equipment, and livestock used in producing the crop.
3. Consult with your tenant
4. Inspect the production activities periodically.

Since almost all farm landlords will perform 3 and 4, you probably will need to fail both 1 and 2.  The key term in both of these tests is one-half or 50%.  If you make sure to have a crop share of the expenses equal to 49% or less and make sure that you do not provide half of the equipment to farm the land, you should not be subject to self-employment tax.

Another tax benefit is that if you are normally subject to self-employment tax, but you receive CRP payments and are also receiving social security income, you will not be subject to self-employment tax on the CRP payments.