“When considering capital structure and debt service, CFO-minded farmers must determine if they have the ability to repay loans and other debts based on their profit margins, market volatility and interest rates. In some cases, farmers might have to finance the growth of their business with more of their own money rather than relying on a lender.”
Farmers who want to make money in today's unpredictable economy would do well to assume a corporate mindset and think like a chief financial officer, a Purdue University agricultural economist says.
With many farm businesses now multi-million-dollar operations and the operating risk in agriculture increasing, producers should focus more time on the financial side of their business, said Mike Boehlje. CFOs think about profitability, capital structure and debt service, size and growth, risk and financial documentation, and creating shareholder value, he said.
CFO-type thinking will help farmers navigate swings in commodity prices and production costs. Although price volatility is inherent to farming, price fluctuations are greater today than they were in the past.
"Now we also have cost volatility, which means that we've got three to four times the volatility in margins that farmers are facing today compared to what they had, say, five or 10 years ago," Boehlje said. "When you have more operating margin volatility that just puts more risk in the business."
To better manage those risks and turn a profit, producers need to understand the three drivers of profitability in any business: margins, asset utilization and financing, Boehlje said.
"We spend a lot of time on margins and thinking about whether our revenues exceed our costs, what our margins are per bushel of corn or per hundredweight of hogs or whatever it might be," he said.
"Asset utilization, or what we call asset turnover, is the number of sales per dollar of assets that we generate. So, even if I don't have the kind of margin that I'd like or have a little bit lower margin on sales, if I've got a lot of sales per dollar of assets I still can have a reasonably profitable business because I'm generating a lot of throughput through my operation based on my asset base."
How farmers finance their business — the third profitability driver — is especially important because it determines the cost they're paying for borrowed money.
When considering capital structure and debt service, CFO-minded farmers must determine if they have the ability to repay loans and other debts based on their profit margins, market volatility and interest rates, Boehlje said. In some cases, farmers might have to finance the growth of their business with more of their own money rather than relying on a lender.