The interaction of farm planning and financing is a concept that’s too often overlooked by growers, but it’s one that can help you reach your goals over time, says Marshall Lamb, research director with the National Peanut Research Laboratory in Dawson, Ga.
“Too many farmers do not plan on where they’re going,” says Lamb.
“We do this in our lab with several hundred growers each year, developing their farm plans so they can go to the bank, and it’s just as important as putting a seed in the ground.”
Too many growers, he says, remember their yields from two, even three years ago, but they don’t remember their debt-to-asset ratio.
“Ultimately, if you want to reach your goals, you need to know your financial progress as well,” says Lamb.
Goals for farm plans must be measurable, he says, and they must be made with the right intent so that growers ultimately can achieve their goals.
These are good times in agriculturally financially,” says Lamb. “U.S. net cash farm income was $59,000 in 2009. In 2010, it grew to $79,000, and it’s forecast in 2011 at roughly $80,000. These are good times mainly because we have good prices.”
By seeing hundreds of farm plans each year, Lamb says he has learned the difference between growers who are doing things right and those who are making mistakes.
“Debt-to-asset ratio is one of the keys if not the key indicator we need to look at,” he says. “We need to come up with a farm plan to generate profits, and profit is yield times price minus cost. Then, we need to look at financial indicators at the end of the year and, hopefully, they’re better than where you started.”
But farm planning and farming is much more difficult than typical business planning and running a business, he says.
“The reason for this is the close connection between environmental and biological processes, some of which are outside the direct control of the farmer, but yet they can directly impact the economic performance of the farm.”
Also, he adds, farmers buy retail and sell wholesale. “You’re told what you’re going to pay for your inputs and you’re told what you’ll get for your outputs, and you’re getting squeezed on both ends. The result is that your profit margins become tight.”
Yields trending upwards
Yields for all U.S. commodities have been trending upwards, a great testament to what the research community has done, says Lamb.
“But when you’re doing your farm planning, be very conservative with yields. The biggest mistake I’ve seen is farmers coming in who have never made 3,500-pound peanuts, but they want to put 3,700-pound peanuts into their farm plan. It is nothing but a first step toward failure.
“When you use your average yields and then use a plus or minus 15 percent variation, I don’t care about the plus. If you yield 15 percent over your average yield, chances are your farm plan is going to have a positive projection. I’m concerned more about your negative side. I always like to see farmers go 15 percent below. I don’t think 10 percent is enough.”
We do have better genetics today, says Lamb, but as former University of Georgia Extension peanut specialist John Baldwin always said, “If it don’t rain, it don’t matter.”
Price volatility, he says, is at an all-time high, according to the Chicago Board of Trade Volatility Index, showing the percent volatility in commodities on an annual basis.
Wheat, historically, has a 20-percent volatility. In 2008-2010, it had a 73-percent volatility. Corn has a historic volatility rate of 22 percent, but in 2008-2010, it was 49 percent. Soybeans have a 23 percent volatility on a historical basis, but 54 percent in 2008-2010. Cotton was 17 percent historically, but 42 percent during that same two-year period, says Lamb. This represents a minimum of a doubling of volatility over the last two years for all of these major commodities.
“With peanuts, when we went into the 2010 crop, contracts were about $500 per ton. For people with un-contracted loan peanuts, they were bailing out at $800 per ton.”
Factors behind the high commodity prices include widespread shortfalls; economic growth in developing countries, especially India and China; U.S. biofuels policy; a weak U.S. dollar that makes exports more competitive; and declining investments in agricultural productivity and research, he says.
Years of under-investment in agriculture in developing countries caused stagnant growth in yields while populations continued to grow, says Lamb.
“It was because their governments stopped putting money into ag research and ag development. If cuts in ag research continue to occur in the U.S., is our country going to go from a developed country to a developing one?”
Production costs have increased in 2011, he says, with fuel being projected to be up 16 percent, and fertilizer up 14 percent. For the first time in the history of the United States, farm expenses are forecast to exceed $300 million.
Based on University of Georgia budgets, farmers saw a 7 percent increase in the cost of producing peanuts, says Lamb.
“What is interesting is how the cost of farming corresponds to the recent price spikes in commodities. Inflationary factors affect production costs, and those production costs will continue to increase.”
Different financial measures
There are a lot of different financial measures, he says, and they all mean something, but there are only a few that are primary indicators and that means a lot. “The debt-to-asset ratio is probably the key ratio that we look for in agriculture. It’s basically total farm liability divided by total farm assets.
“When we do farm plans, we look at our net farm income and our cash flow. But one measure that I think is overlooked is operating profit margin. It shows the operating efficiency of the business, but it also takes into account your ability to market, to manage inputs and your ability to make yields.
“That’s a good indication of how you’re doing as a farmer.”
The debt-to-asset ratio is a great picture right now for U.S. agriculture, says Lamb. Going back to 1985-86, the debt-to-asset ratio was 23 percent.
“In the last five years, we’re gone to about 10 percent, but we have to be careful and not fall asleep with these numbers.
“Our average is 10.2 percent, all farms, but that takes into account farms that don’t have any debt. If we take into account farms that just have debt, the ratio goes up.
“Large farms, even though they may be creating much more revenue, have higher debt-to-asset ratios than small farms.”
A troubling number, he says, is that farmers who are under 35 have a 40 percent debt-to-asset ratio.
“It’s very difficult for them to enter farming with this number on their balance sheets,” he says.
Land values are propping up or dropping down these balance sheets, says Lamb. Looking at the value of farm real estate in the lower Southeast, the average per acre in Georgia is $2,800 to $4,300; in Florida, $4,600 to $13,000; and in Alabama, $1,800 to $2,750.
Farm income and expected earnings determine land value, says Lamb.
“With the commodity prices we’re seeing right now, coupled with current interest rates, you’re looking at expected earnings in agriculture. There’s not nearly as much land being offered right now, and that’s driving up the price of real estate.”
Be conservative with expectations
In summary, Lamb urges growers to be conservative with their yield expectations. Don’t over-estimate your yields if you’ve never reached that yield goal, he says.
And to minimize the impact on your farm income, budget for increases each year. “There’s no doubt inflationary factors will continue to creep in, increasing the cost of producing our food.
“Be honest with yourself — try and reach your goal and not simply try and fool your bank into giving you a loan for another year. You must have goals so you can retire one day.”
Debt-to-asset ratios are at the lowest level in 50 years, and that’s great for American agriculture, says Lamb.
“However, debt-to-asset ratio is heavily influenced by the value of the farmland, which represents 80 percent of the average farm’s net worth.
“Farmland is at a high level, at an unsustainable high level. If prices go down and interest rates go up, your debt-to-asset ratio takes an immediate hit when they re-value your land.
“I’m not sure that on a long-term basis, the land prices we have now are truly sustainable for agricultural production.”
This also creates a large entry barrier for new farmers, he says.
“If they have to go out and rent or buy the land and start farming, it’s almost impossible. The rule of thumb is that a 50-percent reduction in farmland leads to a 35-percent reduction in net worth.
“You have to be prepared for that if you own land at current prices. It can destroy you financially, and we saw it happen in the mid-1980s.”
Finally, he advises, monitor your progress. You need to know from year-to-year if your debt-to-asset ratios are going up, going down or staying static, and you need to fix it. There are ways to fix the problems if you know you have problem, says Lamb.