Minding Ag's Business

Maybe you don't consider your home farm in the same league as the Baltimore Ravens quarterback Joe Flacco, a pro who lobbed a 70-yard touchdown pass with 30 seconds left to tie--and later win--a playoff game. Here's a little secret: Knowing how to tweak your farm financials can elevate you from the equivalent of a farming couch potato to a potential Super Bowl champ like Joe. You just need to know what plays to call.

Comparing two important farm financial ratios--asset turnover and operating efficiency--offer the best long-term predictors of whether your farm excels like an NFL star. "Farmers tell us that finding assets that drive a high asset turnover ratio made all the difference in the success of their business over the last 20 years," says Sam Bachman, a financial analyst with AgriSolutions Inc. in Brighton, Ill. "They've chipped away over time and restructured their asset mix to improve their efficiency."

In essence, the two ratios measure your ability to generate revenue and convert it into profit. Asset turnover ratios measure the revenue that's generated annually from the market value of assets like buildings, machinery, land or cash.

"All those assets need to be doing their job, but as market values for land increase we find it can tie up a lot of capital while spinning off much less revenue than other investments," Bachman says. Identifying under performers like hobby livestock enterprises or buildings also can help tweak your efficiency. Equipment that helps you cover more acres --provided you can expand and earn more revenue--typically generates higher levels of asset turnover.

Someone with a substandard asset turnover ratio of 0.2 can limp by for years if they have little or no debt and a modest lifestyle, Bachman adds. Many conservative farm operators fall in that category (see chart in DTN online editions). But a farm with a 50% debt-to-asset ratio or higher would find that low level turnover unsustainable over time and "is likely dying a slow death," Bachman adds. Some champs in the AgriSolutions database have generated 0.6 ratios or even more than 1.0 over the past five years.

Besides the ability to generate revenue, Bachman likes to benchmark profit margins. In this case, he uses the Farm Financial Standards definition of operating efficiency ratios. That's EBITDA (earnings before interest, taxes, depreciation and amortization) minus owner compensation, divided by the value of farm production. Some AgriSolutions clients have passed the football like Joe in recent years, earning margins in the 50% to 70% category, although 30% is more normal.

If you choose to reinvest in your business, rather than taking a big ownership draw, you can rev that operating efficiency ratio to be a little more competitive, Bachman says. Make sure working capital is 25% of annual revenue or more, and then focus your remaining reinvestment on improving asset turnover and operating efficiency.

If you see a substandard pattern developing, you can take steps to adjust, Bachman says. You could divest of unused or underused equipment, design a sale-leaseback on farmland or rethink a money-losing venture. "Farms consistently below average must have much stronger equity positions and may not maintain the lifestyle of their peers ," Bachman says. "Ultimately, farms consistently under performing will feel pressure. Pressure will lead to fatigue.And fatigue could lead to an exiting of the business." In other words, no Super Bowl titles.

Read and comment on all DTN Ag Business Benchmarks on the Minding Ag Business blog.

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(SK/CZ)

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