- The low-cost producer is the winner
- Pay some taxes
- Producer is capital and profit allocator
In my road warrior travels I recently shared the podium with Matt Roberts, an up-and-coming agricultural economist who is a “must see” speaker at agricultural seminars. Matt is from the Ohio State University. Matt discussed the “Six Hats of a Farmer” in his speech, and had some great points.
In commodity agriculture, the low-cost producer is the winner. With escalating cash rents, land values and input cost, a producer’s cost advantage can quickly disappear when the bidding and growth wars occur in an area. For example, some farmers in Minnesota are now paying over $400/acre cash rent for their land.
The owner of the scarcest resources earns the wealth. This is why owning high-quality land with water will become even more important in the next decade.
Stop listening to your accountant and accept that paying some income taxes might not be such a bad thing, depending on your business goals. Here is an example:
| Scenario A | Scenario B | ||
|---|---|---|---|
| Revenue | $500,000 | $500,000 | |
| Expenses | $300,000 | $350,000 | (Includes $50,000 pickup truck) |
| Taxable income | $200,000 | $150,000 | |
| Tax Rate | 50% | 50% | |
| After Tax | $100,000 | $75,000 | (But you own a pickup truck) |
In Scenario A, the producer ends up with $100,000 on the balance sheet. However, in Scenario B, the producer has a $50,000 truck and $75,000 in cash on the balance sheet.
If your goal is to build working capital for flexibility, pay some taxes. If your goal is to build assets that depreciate – increasing overhead cost – buy a truck or machinery. Unless the depreciable asset increases efficiency, you may be better off paying some taxes and gaining flexibility with cash on the balance sheet.
A producer is a capital and profit allocator. Build a balance sheet through profit management so that net working capital (current assets minus current liabilities) is a minimum of 75¢/bu. for wheat, $1.50/bu. for soybeans and 75¢/bu. for corn to handle increased volatility in profits. See the example below.
| Wheat | Corn | Soybeans | |
|---|---|---|---|
| Acres | 1,000 | 1,000 | 1,000 |
| Bushels/acre | 50 | 240 | 50 |
| Total bushels | 50,000 | 240,000 | 50,000 |
| Price/bushel | $5 | $4 | $8 |
| Revenue | $250,000 | $800,000 | $400,000 |
| Working capital/bushel | 75¢ | 75¢ | $1.50 |
| Total working capital | $37,500 | $60,000 | $75,000 |
Total working capital for the three crops is $172,500, which is 12 percent of total revenue. The bottom line is that 12 percent of revenue is the bare minimum in net working capital to revenue for this case farm. If the farm retains this amount over several years, it will accumulate to 36% of revenue, which is a “green light” metric.
These are some interesting points from the young professor!
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 sullylab@vt.edu.