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Calculating real farm costs and credits

Nobody builds boats to sell them at a loss. Grain growers need to think about that a little. “It doesn’t make sense to be in business to sell grain at a loss,” says Ron Witherspoon, chief executive officer with Interactive Management Group Ltd., in Regina, Saskatchewan. IMG has certified farm consultants across the Prairies.

Cost of production can guide everything from finance management to farm expansion. Photo by Bruce Barker.

Still, he says, it is probable that thousands of farm managers take that approach. They grow it because they want to grow it and enjoy growing it; then they try to sell it, and hope for the best.

Maybe it used to work, but not any more. Farm managers need real books with real numbers at the bank, the credit union, and at their own desk, if they plan to keep farming.

The full-bore recession that began in 2008 changed the way that things happen, even at rural Prairie financial institutions. “The banking industry has been forced to take less risk and demonstrate that they’re taking less risk,” says Witherspoon.

Loan or credit managers in Manitoba, Saskatchewan, Alberta and British Columbia are cutting their risks, and some farms are being cut or denied credit at some level. Even medium and low-risk clients bring a business plan when they visit the credit office. The rest of the growers need more. “It’s best to have a business plan that has multiple scenarios where you show that, even under low yields and low prices, your farm is able to make it through to next year. No one wants to bank a farm that can be put out of business in one year,” Witherspoon says. “The work you have to do to prove you deserve credit has gone up. You have to show your bank that you’ve got a good understanding of your cost of production and of how you will turn a profit. Be able to show them that, under poor prices, or poor moisture, the farm is still going to be able to service its debt.”

The larger the farm, the greater the level of debt, the greater the requirement to have a very accurate cost of production picture for everyone involved.

Three scenarios
For their own security, Witherspoon wants clients developing at least three financial scenarios for themselves as well as creditors. Call them high, low and current. The current scenario has the hard numbers from actual recent bills and receipts; high and low will have a range for the variables of farming, weather, input costs and market swings.
Variability is inherent in farming. Creditors know next year will not be the same as this year. The high and low scenarios need to reflect the facts that weather is variable, prices swing and markets are volatile. “If we showed the farm went bankrupt 30 percent of the time, how many people would like to help it with credit,” he asks.
Calculate the scenarios well in advance of the crop year, in advance of the next credit visit, and continually adjust them as conditions change. Always, look for ways to adjust them for the most favourable outcome.
Maybe a crop adjustment will affect the timeliness of field operations.
Maybe a change in machinery will improve things, maybe not.
Maybe a window of time will let a grower farm more land.
Maybe moisture conditions are changing the outlook.
Maybe it is worth high-value labour for a few critical weeks of field operations.   

Depth perception
Clients who only look at their own farm scenarios are in danger of tunnel vision, Witherspoon warns. They need a second, non-personal outlook on the farm plan, a kind of depth perception, obtained by looking at the bigger picture in farming. It is a reality check, a benchmark. “What’s more important is to know how your costs compare to your neighbours. To be long-term financially viable, you have to be on par with your neighbors, and preferably have a better cost scenario.”

This is not about the neighbour across the road. It is the growers with similar soils, similar crops, similar risks in a particular region. A few growers are in clubs where they can share confidential information, but most are not.
This is where it pays to network with ag reps, programs and ag management consultants.

Provincial cost-of-production information is online and free for the public as a basic benchmarking source. For more depth perception, he suggests, discuss benchmarks with knowledgeable individuals at grain companies or producer associations.

Scenario analysis
“Scenario analyses” reveals the best route to bring one farm into a profitable situation it is one way to convert and expand into a mixed operation. Witherspoon says, “It would have been impossible to make a good business decision without having this cost of production information put into a financial modelling program. At the end of the day the decision was made on the basis of best long-term return on investment.”

Another farm struggled to cope with dramatic swings in both canola prices and fertilizer prices. Scenario analyses enable the manager to resolve the problem by locking in prices for canola he would deliver. “Looking at your cost of production, if you’re able to lock in prices you have more comfort and you can spend that amount of money to hit a target yield,” Witherspoon says. “You’re trying to reduce risk.”

Many scenarios showed that the outlook for potential grain returns in 2009 did not look very promising. Managers adjusted their plans for farming practices to lower the variability of outcomes, based on revenue they could expect, and presented those scenarios to creditors.

It comes down to this: “You can restrain your costs in certain areas, but in others you really can’t do much. You can cut fertilizer, but you can’t really cut fuel significantly. So, focus on areas where you can manage the input risk in relation to the profit potential.”

It is in a grower’s best interest, he adds. The focus on seeding without a marketing plan, like building boats without a marketing plan, can lead to wasted time and lower returns.

A 6000-acre farm was planning to add 1200 acres of seeding to make more profit. Witherspoon studied the numbers and discovered a better plan. “I showed them that if they did a 10 percent better job of marketing, they would add more profit to their farm than if they increased the size of their farm by 20 percent,” he says. It also took less work.