In my last article, an examination of summary statistics from the farm management education database in Minnesota, provided by Al Brudelie, was analyzed from a profit standpoint. Now let us further examine farm financial standards that were used to benchmark success. In a recent seminar, much of the focus was on efficiency and growth. The slogan was “better is better” before “bigger is better.” A business can run into difficulty growing their way to profit, without concern for efficiency and margin.
Margin management can be measured by the operating expense to revenue ratio, excluding interest and depreciation. For example, if revenues are $1 million and expenses are $700,000, excluding interest and depreciation, the calculated ratio would be 70%. This means 70% of revenue is going toward covering operating expenses, leaving 30% of revenue to use for other purposes.
Your next question may be, is a 30% margin good in today's economic environment? The answer is yes. The top 10% and high 20% of producers in the Minnesota database reported an operating expense to revenue ratio last year of 62%, which leaves a margin of 38%. Interestingly enough, the average producers had a 67% ratio, which should make them feel very good. If you are thinking that these favorable benchmarks come only from the crop sector, you will be interested to know that this database represents a combination of both crop and livestock operations.
The low 20% of producers continue to struggle. The ratio improved from last year's level of 101.5%, which indicates negative margins, but was still a dismal 87% in 2010. Further examination finds over a 15-year time span, the ratio was above 90% for six of the 15 years, and it was above 80% for the whole time span for the low group. Contrast this to elite performers, where the ratio was only above 70% for 20% of the time.
One might wonder how the low 20% of producers stay in business.
- Use of non-farm income
- Refinancing using appreciation of assets as long as the lender will allow
- An occasional sale of capital assets to provide cash flow
In the end, this is the recipe for decline in wealth. Contrast this to peak performers. If they utilize profits well, the margin becomes earned net worth, which will give a twinkle in the eye of any lender, if they borrow money.
Next in this series, we will examine debt and debt service.
Editor’s note: Dave Kohl, Corn & Soybean Digest trends editor, is an ag economist specializing in business management and ag finance. He recently retired from Virginia Tech, but continues to conduct applied research and travel extensively in the U.S. and Canada, teaching ag and banking seminars and speaking to producer and agribusiness groups. He can be reached at firstname.lastname@example.org.