Scheve: Thinking Of The Farm As A Business
Apr 16, 2018
Market Commentary for 4/13/18
Corn and bean basis has remained strong, or even slightly improved for April delivery, even with the recent futures rally. This likely indicates limited farmer selling and/or good demand. It’s been a while since we’ve seen this type of market situation, and it suggests potentially higher prices going forward.
I expect the 2018 marketing year to be much different than 2017, but I have my plan in place ready to take advantage of opportunities that become available. In order to do this effectively, it’s imperative to know my breakeven price. Several Midwest universities have published their corn and bean breakeven cost structures for various farmers across the Midwest. While I may disagree with a few line items on their budgets, their overall numbers are values that I think are reasonable levels for the average farmer to use as a goals for their own budgets.
Thinking Of The Farm As A Business
I suggest that farmers look at their farm operation as a large company with multiple profit centers working to a common goal. Each profit center must “pull its own weight” without drawing profits from other divisions. Successful farmers understand each profit center independently and how it maximizes profit for the farm operation.
There are four large divisions (some with smaller subsets) that I look at:
- Land Ownership
- Custom Machine Operations
- Grain Storage Facility
Since farmers are naturally passionate about working the land, this is where I see the most “cheating.” I ask all my clients, “Are you paying yourself a fair market rental price for use of your own land?” In theory, some farmers could spend all of their time on the beach, while renting out all of their farmland. Considering the typical farmer’s mentality, few think like this, but they should. The most successful operations understand the profit from land ownership comes from a long-term investment.
This long-term investment could have been made when the land was purchased 20 years ago at cheaper values or recently at higher prices. Either way there is a fair market rental price based upon the local market conditions for every farm out there. From the start of budget preparations this rental value needs to be calculated to understand the possible guaranteed income a farmer is giving up in order to actually farm their own land
Farmers frequently tell me that if they figured the fair market rental prices for land they have owned for 20 years that they won’t make a profit on all the other land that they rent. If so, this might indicate other divisions within their operation are not as efficient as they should be. Or it could simply mean the farmer might be paying too much for the additional rented ground.
Sometimes farmers say they need to adjust prices based upon entire farms instead of field by field. While there are two schools of thought on this subject, I tend to think each farm, not field, should stand on its own. There will always be a field or two that aren’t necessarily profitable within a group of fields rented from each landowner, but it can be justified as long as that entire farm makes up for those few loser fields. However, the balance of the other farms in the operation shouldn’t subsidize any other farm in any operation in my opinion.
Profitable farmers also understand the cost of every piece of equipment. Most mid-sized farmers today could have over $1 million invested in equipment, so it’s important to be as efficient as possible. Following are questions that should be asked of every piece of equipment (i.e. planter, combine, sprayer, semi, tractor, etc.)
- What is the local custom rate for each piece of equipment you need if hired done?
- What is the yearly maintenance cost for each piece of equipment needed (e.g. 5 year avg)?
- What are the yearly depreciation costs?
- Is there profit potential in owning equipment and doing custom hire work?
- Is owning, renting, leasing or hiring another farmer a better option?
Bankers always include depreciation in their budget estimates, but farmers tend to disregard it because it’s not an actual cash expense each year. I too have always hated this line item because it doesn’t reflect anything tangible and is too easy to “fudge.”
Often farmers will “mine” the equity on their equipment by not paying themselves enough per acre to use it and replace it.This may be fine for a short time, but years later replacing equipment becomes too expensive, potentially leaving the farmer in a difficult position down the road. This is where the depreciation that should have been budgeted in each year catches up with a farmer.
That’s why I prefer to use custom rates in my budget instead of loans, depreciation, repairs, fuel and labor independently. Putting more acres on machines doesn’t usually decrease one’s overall cost per acre much, if all these expenses are included the costs are still about the same. For example, think of two identical used combines except one has 1000 more hours on it. No one would value those two combines at the same price because there is always a cost to using equipment beyond just fuel and labor.
When a farmer tells me they can't make a profit using University breakeven levels with custom equipment rates, I'm concerned. Without a significant rally, this farmer will have a difficult time being profitable. Usually farmers in this situation are paying very high land rents and are likely not accounting for true equipment costs. Although I have seen situations where a small farmer might not have enough acres to warrant purchasing some, or maybe even all, of their equipment.
Grain storage is a profit center many producers use incorrectly. Most farmers store non-contracted grain, hoping for a market rally, because storing unpriced grain at their local elevator means hefty charges. Between storing unpriced grain at home for “free” or storing it at an elevator for a charge, it can make a little sense I guess.
However, many farmers are missing out on all of the profitable benefits of storing grain at home while selling forward to take advantage of carry and basis appreciation. By considering on-farm grain storage as a separate cost center, analyzing the expense to build new storage becomes a practical one. One just needs to analyze the premiums received from carry and basis optimization against the expense of building new bins. Almost every time I walk a client through the numbers, having on-farm grain storage is a profitable venture. Actually, I find grain storage can have the best return on investment above every other investment in a farm operation.
The “farmer” is the part of you that makes management decisions each year. It’s similar to a CEO position with strategic decisions that need to be made on crop inputs and farm operations:
- Fertilizer – What kind? How much? When to apply?
- Chemicals – What kind? How much? When to apply?
- Seed/Agronomy – How much corn vs beans? On which fields? Which brands/hybrids/traits?
- Insurance – How much? What program?
- Hired Help – How much? Where do I find these people? How much to pay?
- Marketing – When to sell. Was that a profitable price? What I too greedy in my goal?
- Strategic Planning – Should I rent or buy more ground? Should I drop a low producing field?
There are so many decisions for farmers to make, it can sometimes be overwhelming. To help in budgeting, I ask my clients – How much do you want to make on each acre they farm. Each farm is different and has its own challenges, but these questions should be answered by not only the big established family farms but also the small young farmers renting all of their land.
Putting It Together
Finally, the farmer puts all of these profit centers together to form a budget (or business plan, but farmers don’t usually call it that). Then a marketing plan can be developed to try and ensure the farm is profitable. If each profit center is optimized, the biggest opportunities for the farm operation can be achieved.
Some may think all of this is just part of being a farmer, but breaking up the divisions/profit centers independently and then optimizing each one can help maximize profits. Perhaps there is a weak division/profit center that was only exposed after doing the analysis. Farmers can then take steps to maximize each area.
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