Farm management, finances make difference in profit

The other day one of my former students who is now a farm management educator sent me a financial data summary of the producers he works with. The summary was sorted by net income into low, middle, and high one-third producer groups. My assignment was to examine the database summary and present an opinion on the numbers concerning management and financial practices. The following are some core perspectives gleaned from the summary data.

Asset Turnover

One striking difference between the low and the high group in net profits was the asset turnover ratio, which measures how efficiently assets are being utilized to generate revenue. The high group turned their assets much faster, which was either the result of more revenue generated, or a less expensive asset base. The weak link in American agricultural competitiveness is overhead cost, comprised primarily of high land values and cash rents. Only time will tell whether land values and cash rents correct. Lower asset values compared to revenue will improve this ratio.

Coverage Ratio

Another difference I noticed was in debt servicing ability, measured by the term debt coverage ratio. The high group had a 500+% ratio, while the low group had a ratio of 150%. After replacement of capital assets was interjected in the calculation, this coverage ratio declined to 116% for the low group. In the next downturn, capital replacement, i.e. machinery and equipment purchases, and failure to pay down operating lines of credit will emerge as issues particularly for the low group.

Profit Margin

The next big factor was operating profit margin. The high group’s profit margin was almost double the low group’s margin. In discussion with the educator, he indicated the producers in the high group execute risk management, operational, and financial plans. Too often, a plan not executed is a road to negative profits.

Another observation found that the low group carried higher debt to asset ratios overall, but the average ratio was only 14 percent higher for the low group when compared to the high group. Surprisingly, there was very little difference in working capital reserves between the low and high groups. Sometimes the numbers do not show the difference makers. Think about the difference makers in your business model, and then benchmark your business to others.