I have met a number of farmers who are obsessed with farming more acres. But remember, there is little correlation between size and profitability in terms of return on equity.
My concern is that several generations of wealth could be destroyed if an operation implodes due to rapid growth. It has happened, even recently with $6 to $7 corn.
Based on years of observing successful farm businesses grow, I feel strongly that growth should be the result of doing things right—not an objective. My partner and cofounder of Russell Consulting Group, Terry Jones, started farming in 1983 with 90 acres.
Today, he and his brother have wisely expanded their operation.
The problem with having growth as a major objective is that it often becomes the overriding objective of the farm. Other factors start slipping through the cracks, and the result is that the
bottom line deteriorates.
A better objective is profit, which should be viewed as the cost of stay-ing in business and capitalizing on your growth. You should budget for it.
When we build a pro forma operating plan with our clients, we add term debt payments, projected
operating expenses, living or operator draw, depreciation and a profit. All five added together become the gross-dollar-per-acre goal. That also cements the marketing objective for the coming year.
The minimum profit-per-acre goal should be $100 per acre, though recent profits have been better than that. In fact, many of our client plans for 2012 show $200 to $300 per acre profit. With 45% of anticipated 2012 bushels price-protected that should be attainable.
When we started to use this operating plan 13 years ago, the objec-tive was $50 per acre profit. That is not enough money today, due to increased volatility and risk exposure—more dollars are needed to grow a crop.
Oftentimes when growth is the primary objective, the farm business is not capitalized at a proper level to allow the operation to withstand unexpected adversity.
Working capital is the first financial gauge to watch in your business. How much is enough? We recommend that the dollar amount of working capital be a minimum of 50% of annual expenses. Some producers use annual revenue, which works too.
This financial gauge is a better standard than a current ratio standard because your current ratio (current assets divided by current liabilities) can vary depending on the time of year it is calculated.
Maintaining a proper level of working capital is the first shock absorber to get you through the financial bumps during periods of growth. Unfortunately, some large operations don’t have enough working capital.
The bottom line is, you have to be better than average to survive in the commodity production business. If you are far better than average, there is a tremendous amount of wealth to be created in the farming business.