You wouldn't run your machinery week after week without checking for indicators that there's trouble brewing. You shouldn't run your business that way either. "Financial gauges help you make changes to improve farm performance," says Moe Russell, president of Russell Consulting Group in Panora, Iowa.
Machinery Costs per Acre: The easiest way to calculate machinery costs per acre is to look at the current market value of the equipment and then take 25% of that as an annual cost, Russell says. The 25% should be made up of three things: 10% depreciation, 10% interest (or opportunity cost) and 5% repairs. If the line of equipment is older, repairs would be greater than 5% but depreciation would be less than 10%. Along the same lines, if equipment is new, repairs would be zero but depreciation would be greater than 10%. "We have found this is a very accurate gauge for farmers to watch," Russell says.
Labor Costs per Acre: Machinery plus labor costs can impact the bottom line even more than input costs, Russell says. "It's best to combine both machinery and labor costs when doing any benchmarking, because the same goal can be achieved by either better equipment and less labor or older equipment and more labor," he says. Russell suggests producers use the amount paid for the family living/operator draw (assuming a cash grain operation), add to it all hired labor costs and then divide by harvested acres. If you double-crop soybeans after wheat, for example, you should add in both acre counts.
Return on equity (ROE): is the net income after operating expenses, labor and interest charges are covered. It is a measure of the return the owner receives on invested capital. A rate of return on equity that is less than the rate of return on assets indicates a producer is achieving a lower average return on assets than he is paying for debt leverage, says Dick Wittman, farm financial consultant in Culdesac, Idaho, and past president of the Farm Financial Standards Council. "This points to potential problems in operating efficiency or capital asset use," he adds.
Debt-to-asset Ration: The debt-to-asset ratio is total liabilities divided by total assets. This is the basic leverage of the farm business, and it measures the operation's ability to repay all financial obligations if all assets were sold. While many lenders advocate 40% as the magic number, Wittman cautions that the right number for a farm can vary significantly. Highly efficient farms can often service a higher debt load; those with a high percentage of leased assets also can usually handle a higher leverage ratio than farms with a large ownership base.
Operating profit margin (OPM): is a key indicator of a farm's operating efficiency, Wittman says. It is calculated by dividing the farm's operating margin (net farm income from operations + interest expense – value of unpaid labor) by total farm revenue. Strategies that lower input costs or spread overhead over more revenue can improve this indicator, Wittman explains. Optimizing equipment procurement with least-cost methods, such as leasing or sharing equipment, is an example of a strategy producers can use to significantly impact OPM.
> For more information on key financial ratios, visit the Farm Financial Standards Council at www.ffsc.org.
Top Producer, October 2009
- OCTOBER 2009