Business Analysis Made Easy
Helping producers distill business analysis to a plan-on-a-page was the focus of a recent project coordinated by the Western Farm Business Farm Management (FBFM) Association in Illinois. Funded by North Central Extension Risk Management Education through a grant from the USDA National Institute of Food and Agriculture, the project enhanced the traditional business analysis practices of FBFM’s participants.
“Our goal is to create new, abbreviated benchmarking tools that producers can use to analyze their business,” says Bob Rhea, project director. “Participants of our program receive the traditional, individualized business reports of their annual financial performance and production data. These reports are very detailed and may include several pages.”
The plan-on-a-page analysis supplements the detailed reports by drawing from these the key measuring points and then framing them in a four-year plan.
“The plan provides a big-picture look at a producer’s farm business,” says Rhea. “It identifies critical production and financial benchmarks for two previous years as well as the current year. It also provides estimates for the coming year. This results in a four-year plan that producers can use to forecast cost reductions that may improve profitability and cash flow.”
The project was implemented in 2015, which happened to be a year of financial hardship for farmers.
“At the time, we didn’t know we were having the lowest income year on record,” Rhea says. “Along with declining profitability, there was erosion of net worth. Producers needed a plan to do things differently in 2016.”
With its focus on measuring and estimating profitability and cash flow, the plan-on-a-page business analysis makes it easier for producers to find ways to manage production and finances in ways that help them better navigate financial difficulty.
Using measurements of profitability and cash flow to guide business-management decisions holds particular importance in today’s financial climate, says Rhea. In times of increasing financial difficulty, measuring and managing cash flow becomes even more important than managing profitability.
“Your business can be profitable while still being deficient in cash flow,” he says. “You could have a profit of $80,000, for instance, but still be short $30,000 in order to service family living costs or debt payments.”
For some of the nearly 100 participants in the plan-on-a-page project, the business analysis and forecasting processes resulted in significant financial improvement. One family turned a loss of $200,000 in 2015 to a profit of $75,000 the next year.
Another producer implemented six steps to improve cash flow by $125,000 (see story on the next page).
“Certainly not all participants in the project were able to make such significant improvements to cash flow or to profitability,” says Rhea. “They were certainly able to improve their financial position overall, though.”
Here are the six steps project participants followed to distill their business records into a plan-on-a-page.
1. Identify six financial measuring points from business-analysis records. These measuring points included interest as a percentage of gross revenue, debt-to-asset percentage, operating expense as a percentage of gross revenue, depreciation as a percentage of gross revenue, family living as a percentage of gross revenue, and working capital as a percentage of gross revenue.
2. Establish a track record of measuring points. To get a picture of possible patterns in the financial performance of their operations, participants recorded these measuring points from the previous two years of business records, as well as from the current year’s records.
3. Benchmark numbers against peer groups. Project organizers compiled the measuring points for all participants in the FBFM program and broke these down by age group. This breakdown helped project participants see how their financial performance compared against that of producers of similar age. For this comparison, averages for three age groups were presented: producers older than 60, those between 59 and 50, and those between 49 and 40.
“Family living costs, debt-to-asset ratios, and interest as a percentage of gross revenue are particularly dependent on age,” says Rhea. “If you compare these numbers with those of someone from your same age group, it’s easier to see what might need to be changed.”
4. Figure production costs. From existing records, participants identified production costs for corn and soybeans. Expense categories included costs for fertility, seed, chemical, power, insurance, rent, and labor.
5. Determine production benchmarks. Like the financial measuring points, three years of production benchmarks were presented on the plan-on-a-page. These included yield and price for both corn and soybeans, along with gross revenue per acre, and crop input costs per acre.
6. Forecast coming year’s performance. Producers analyzed cost categories to find ways to reduce expenses, including family living costs. From this review, they projected the coming year’s per-crop costs for crop inputs, machinery, overhead, and land.
This gave a total cost per acre by crop. From this, combined with yield predictions, they established a per-bushel break-even price.
“Forecasting ways to reduce costs as a means of improving profitability and cash flow really encourages out-of-the box thinking,” says Rhea. “Reviewing the summarized financial and production performances on a plan-on-a-page helps producers write a future business plan for greater success.”
Small Steps to cutting costs
Producers participating in the Western Farm Business Farm Management plan-on-a-page project in Illinois found various ways to reduce production costs as a means of improving their financial picture.
“Some farmers found ways to reduce costs relating to cash rent by choosing to let go of high-rent land,” says Bob Rhea, project director. “Others were able to engage landlords in a multiyear plan for reducing rent. For instance, the first year their rent might be decreased by $15 an acre. The second year, the rent would decrease by another $10 an acre. The third year, it would decrease further.”
Savings in input costs resulted from a close analysis of cost benefits and more strategic application of fertilizer depending on existing soil nutrient load.
“Some producers reduced capital replacement costs by holding equipment for a longer period of time rather than replacing it,” says Rhea. “Selling unnecessary pieces of equipment also resulted in cost savings.”
The farmer who realized an increased cash flow in the amount of $125,000 used several means to accomplish it. For starters, he reduced capital purchases by repairing a tractor rather than replacing it.
He also restructured debt. “He had some short-term debt that he was able to restructure into intermediate debt,” says Rhea. “That reduced his annual debt-service requirement.
“By soil-testing, the farmer found he could reduce input costs by applying less fertilizer for one year without harming yields,” Rhea adds.
In sum, a significant reduction in costs can result from shaving expenses in several areas. “You just take small steps, and eventually you hit your targeted number for overall cost reduction,” says Rhea.