As advisors, we see many business and farm financial statements through out the year.  Most of the successful farm businesses have several key financial ratios in common.  Even though each farm business is different, it is surprising how these ratios tend to be in the same range for each business.

These key ratios that we look at are as follows:

• Current Ratio – This is the ratio of current assets comprised of cash, inventories and receivables divided by current liabilities comprised of short-term notes payable, accounts payable, accrued liabilities and current portion of long-term debt.  This ratio determines how much of your assets will be available to pay off the debts owed over the next year.  It is important to include any long-term debt that will be paid off in the next year.  This ratio should exceed 2:1 and for most successful farm businesses, it is usually over 3:1.

• Net Worth to Debt – This is the ratio of your farm net worth divided by the total debt of the farm.  The higher the ratio the less your farm is leveraged.  Most successful farms will have a ratio that exceeds 2:1 and in most cases will approach 5:1.  A starting farmer’s ratio will usually be much lower than a long-term many generation farmer.  This is one of the ratios that bankers will always put the most importance on.

• EBIDTA – This is your farm earnings before interest, depreciation, taxes and amortization.  The reason this ratio is important is that it places each farm operation on the same level, i.e., you are able to compare a farm bought for cash to a farm bought with debt.  This will let you know for each farm or farm unit what income is being generated by the farm.  This income should always have an expense component for the farmer’s salary to make it comparable to other businesses.  The ratio of EBIDTA to net farm sales will vary greatly depending on the type of farm crop grown, but in general, we should see a ratio that exceeds 20% or more.

• Machinery costs to sales – This ratio seems to be one of the best ratios in determining how profitable a farm is.  The lower that a farm operation can keep this number, then this farm will usually end up in the upper farms in profitability.  Some farmers will lease new equipment each year while others will keep the same farm iron forever, the key is to keep this ratio as low as possible and still get the crop grown and harvested.

I have given you four of the key ratios that I see.  Have you computed yours and are there others that you use on an annual basis.  Let me know!

I have enjoyed doing my blog for about a year now and have now started to see some farmers using a blog to communicate with their landlords, neighbors, bankers and others that might be interested.

Reading the latest issue of Successful Farming, I noted an article on the Martin Family Farms in Logan County, Illinois.   The title of the article was “Communication keys their success”.  It was a very good article on how communication between parents and children, employer and employee, and tenant and landlord are extremely important to a successful farm operation (or any business).

Doug Martin decided to create a blog to keep his landlords apprised of what is happening on the farm.  Many of his landlords are located in very distant states such as California.  By using the blog, the Martin’s keep their landlords informed and share what is happening in a real-time efficient manner.  “Anything we can do to communicate to our landlords that they are a part of us, helps them feel a part of the operation.”  I think like most things in life, landlords would rather be part of a good farm community than simply leasing their land each year to the highest bidder.

I would strongly suggest trying to do a similar blog.  I think it would well be worth the effort even if you are not computer savvy.

Here is the Martin Family Farm blog.

For those people living in rural areas, the smells associated with hogs, cows, etc. can be a nuisance.  Usually most people grin and bear it, however, there are many times when they try to do something about it.

The High Plains Midwest Ag Journal recently reported on a civil trial filed in Kansas City regarding the hog odors from a large commercial hog operation about 80 miles north of Kansas City.  This operation usually contains about 80,000 head of hogs and encompasses over 2,000 acres.  Fourteen rural neighbors had already received $100,000 apiece from a 1999 lawsuit, however, they have taken Premium Standard Farms back to court arguing that these payments are not enough to compensate them for the continuing odors.

The company argues that they are not suffering “substantial impairment” from the odors.  They agree that hogs stink, but it does not meet the qualifications of a nuisance under the law.

Kansas City attorney Charlie Speer has won over $10 million from Premium Standard and its affiliates since 1999 on these types of cases.  In 2009, he indicated a lawsuit that was settled for $1.2 million will “set the bar” for future cases.

PSF attorneys contend these lawsuits are driven only by money and are causing damage to the local ag economy.

I believe that both sides have some merit to their cases.  These smells can be overpowering when you have that many animals in a small area, however, most people living in farm country usually know this when they move there.  I think, however, that these large operators sometimes believe it is cheaper to just settle the lawsuits than to try to fix the problem which can cost substantially more.

To maximize your profit for your farm, it is very important to determine what your annual fixed costs are and determine if you are maximizing your amortization of these costs on your farm.  Fixed costs are those costs that do not materially change with production increases and decreases. 

Some examples of fixed costs are:

• Depreciation on your equipment
• Insurance costs on equipment
• Your annual salary cost for providing services to the farm operation
• Office related costs
• Other annuals salaries for workers who are not at full capacity

These costs are mostly fixed and if you can increase your production to full capacity, these costs per unit of production will decrease substantially.  The goal is to maximize your production to equal the full amortization of these fixed costs.

Lets say you have a farm with 1,000 acres of production and your total annual fixed costs are $100,000.  This means your average fixed cost per acre is $100.  If you have enough equipment and capacity to farm 2,000 acres and all of your variable costs will remain the same, you will reduce your fixed cost amortization from $100 to $50.  This will result in additional profits to the farm operation of $50,000.

Try calculating these costs for your farm operation and see how it would effect your bottom line.

However, you also need to be careful that as you approach full capacity, you may have to make major investments to go slightly over full capacity.  This can then put your back with higher fixed cost amortization.

In a recent issue of Top Producer magazine, an article was written by Linda Smith about how agricultural managers are dealing with the Gen X and Gen Y generation.

I know that being a parent of 4 Gen Y boys that you need to deal with them differently from people from my generation (the baby boomers).

In dealing with Gen X workers, we need to realize that it is much more important for the boss to be a mentor or coach to their Gen X employees than just the “BOSS”.  If not, you will lose these workers extremely fast.  We also need to realize that Gen X are not wrong in this approach, but rather, this is what is important to them.  If we try to change them, we will fail.

For Gen Y workers, they have more of an entitlement mentality due to receiving trophies from simply participating in sports as kids and receiving stuff from their parents instead of time.  When they enter the work force, this transition from college can be tough on them.

They are more willing to accept authority, however, they are not really compliant.  They are results oriented, not process oriented.  Also, we need to realize that this generation grew up communicating more by text than face to face.  Therefore, it is unrealistic to restrict or eliminate their use of e-mail and texting. 

They want a coach and to be part of a successful team.  Make sure to be that coach for them.

Mike Walsten from the “Your Precious Land” has posted recently that farmland sold at auctions are still enjoying high prices.

Mike also was interviewed on Ag Day last week and one of his interesting comments related to the trend of farmers in the metro Chicago area.  When pricing for development land was very high during the mid 2000’s, these farmers were able to sell their farm land for upwards of $15,000 an acre and then reinvest it tax-deferred under Section 1031 of the Internal Revenue Code.  They mostly reinvested in three or four times the land located in more rural areas.

Now, with the drying up of development potential, many of these farmers are now going back to the people they sold their land to for maybe $20,000 an acre and re-purchasing it for $5,000 to $7,500.  I think you will see this trend continue for a couple of more years.  Then, when the development trend starts again (and based upon a growing population, it will start again sometime), these same farmers might be able to sell the land for $20,000 an acre or more again.

It seems like some of the best investors over the last decade have been our farmers.  It has been a long-time since we could say that.

One of the shows that I have taped on my DVR each day is AgDay.  It comes on in the morning at 6 am and when I get home from work, that is usually the first thing that I watch on TV.  The parent of AgDay, Farm Journal Media has launched a new monthly TV show in conjunction with Pioneer Seeds called Legacy by Design.  It is hosted by my friend Kevin Spafford and the first inaugural show is on AgDay today. 

I look forward to watching the show and see how it evolves over time.  The Legacy by Design site is dedicated to helping farmers transition their farm operation from the current generation to the next or the ones after that.  As our farmers are aging, many of the children that used to hang around and farm are no longer doing that.  It is nice to see the ones that are.

Keep up the good work Kevin and staff and let’s see how the show grows.

Sort of like the photo of my motorcycle at the left, broadband Internet services are much faster than dial up (or in my case a Harley).  Historically, the utilization of broadband Internet services in the rural sector has been much lower than urban areas.

In an article in the September, 2009 Amber Waves , several observations about these issues were made.  By 2007, about 82% of the homes that had Internet service were using a broadband connection.  However, only 70% of rural areas had broadband which is about 15% behind urban utilization.  Clusters of very low service are located in the Dakotas, eastern Montana and Oregon and northern Minnesota.

An interesting conclusion was that rural counties that had broadband service on a quicker basis than other rural counties ended up with better job and economic growth than those without starting in  2000.  This difference in growth rates ranged up to 2% more in 2005 and 2006 and income levels were almost 3% higher in certain years.  Broadband service allows rural America to compete with urban areas since communicating at broadband electronic speeds shrinks the miles to almost nothing from a business standpoint.

Urban areas with low income levels still had broadband coverage of about 75% while rural areas with the same income only had about 50% penetration.  The gap for higher income levels in rural versus urban areas were much lower.

I am firm believer that countries such as Korea (with some of the fastest broadband service in the world), China, Brazil etc. that are deploying fast broadband service will catch up and possibly pass us much faster than if they did not have broadband.  This world is getting much flatter and the rural parts of America are catching up, but still have a ways to go.

All in all, farm debt levels have increased, however, farmers have done a very good job of not letting these levels get out of control.

The United States Department of Agriculture has a very good print and online magazine called Amber Waves.  Each issue generally has several good articles related to farming and I would highly recommend reading it each month.

In the December issue, the an article on how farm debt has increased and shifted in the last few years was highly informative.  Here are the highlights of the article:

• Farm debt levels have risen sharply in recent years, but the growth in farm asset values has outpaced the growth in debt. 
• Fewer farms end the year with debt outstanding than in the past; debt is more concentrated in larger farms
• Debt repayment capacity is expected to decrease this year, but remains well above levels seen in the later 1970s and early 1980s

US farm sector debt was estimated at $240 billion at the end of 2008, however it is expected to decrease by about $6 billion to $234 billion at the end of 2009.  Total farm assets are estimated at about $1.8 trillion for a debt to asset ratio of only 13%.  This ratio is about 2.7 times better than the low reached in the mid-1980s farm crisis.

In 1986, nearly 60% of farms reported having outstanding debt at the end of the year; by 2007, this figure had dropped to 31%.  Larger farms are more likely to use debt than smaller farms.  The majority of small farms indicated they have sufficient liquidity to finance their operations.  Livestock operations tend to have higher levels of debt than crop operations.

At the end of 2007, 65% of farmers reported having no outstanding on their business balance sheet, however, these farms only average about 258 acres in size.  14% of farms reporting between $1 and $5 million in sales also reported having no debt outstanding at year-end.

Farms that reported having multiple loans with multiple lenders only represented 6% of farms, however, they had more than 31% of total farm debt outstanding.

Farm debt has increased more slowly than income.  As a result, the ratio of debt to income has trended down from a ratio of five times annual farm income to less than three times annual income in 2007.

Debt repayment capacity utilization (DRCU) measures debt obligations in relation to maximum debt repayment capabilities.  The lower the DRCU number the better.  This measure has decreased from 27% in 2007 to about 18% in 2008.

The Kansas State University Department of Agricultural Economics periodically produces a recap of the high 1/3, mid 1/3 and low 1/3 of various farms in their state.  They just released the latest analysis for corn, sorghum, wheat, soybeans and alfalfa for the three years 2006-2008.  The total number of crop farms reporting for all three years during this analysis was 629 farms.  There are several pages of producer returns, but I thought I would try to recap the major trends that I spotted.  These trends are based upon the differences between the top 1/3 and the bottom 1/3.

CORN

• The yield per acre difference was about 16 bushels for non-irrigated corn or about 18% while the price difference was only 13 cents or 3.6%.  The total average revenue difference was $61 per acre.
• Major costs variances were in fertilizer and machinery with these costs being about $49 lower for the top 1/3.
• The overall net return to management in the top third was $150 more than the bottom third.

SOYBEANS

• Yields for good producers was about 6 bushels higher or about 20%.  The net selling price was about 55 cents higher or about 7%.
• Total revenue was $72 higher or about 31%
• Again, machinery costs were materially lower for good producers at about $30 per acre lower.
• Good producers returned $130 more per acre than the low producers.

WHEAT

• Yield was about 6 bushels higher or about 19% better for the top 1/3.
• Prices were only about 4% higher than the bottom third or 23 cents overall.
• Again, machinery and fertilizer costs were about $46 lower for the better producers.
• Overall, the best producers gained $120 per acre over the bottom producers.

Other trends are:

• In all cases, the lower 1/3 of farms reporting had negative net income for this three year period, with wheat and corn growers being the worst off compared to the other crops.
• For non-irrigated crops, soybeans appeared to be the best return per acre compared to the other crops, however, the difference between returns for each 1/3 was only about $25 plus or minus per acre.
• As we have discussed in other posts, it appears that the best way to increase your return per acre is to minimize your equipment cost per acre.  This is by far the most consistent cost that is almost always higher for the lower third than the top third.

How does your operation stack up.