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Farm fit

Maybe the phrase “Standardized Financial Benchmarks for Canadian Farm Financial Statements” doesn’t instantly get your blood pumping. But read on. Could this be the tool that lets you control your future?

Like many others, Larry Martin is convinced that Canada’s agriculture is evolving far faster than anyone driving a few miles of country sideroad could guess. The scenery hasn’t changed. At least, it hasn’t been transformed. It’s still a patchwork of crisp farmsteads and open fields, and of barns and bins.

But those who live here know there’s something different in the people. Or, more accurately, there’s something different about their capability. That’s what is driving the evolution.

Except… how much does anyone here really know? Sure, it’s easy to spot the new paint, and yes, the local buzz keeps you up to date on who’s taking over what ground. But what is the reality behind those appearances? Who is tossing and turning all night? Who should be?

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Tom Button

More to the point, where is your own farm in that mix?

In theory and probably in practice, the farms with the best overall financial performance as a result of their combined production, marketing and management decisions, are the healthiest farms and have the best outlook. In that context, how fit is your operation? Does anyone know?

Are there things that other farmers in your industry are doing better than you, and that with a bit of focus, you could capitalize on too?

Or, if you’re already doing comparatively well, where do you go from here? Do you add more land? Or diversify?

It’s a lot of questions, and there may be a new way to inject a lot of insight into answering them.

Martin is a former ag economist at the University of Guelph and is now a principal of Agri-Food Management Excellence, the group teaches CTEAM. He’s also a new inductee in the Canadian Agricultural Hall of Fame, and he’s convinced the spread between the financial performance of neighbouring farms is real, and it can be analyzed for insights that will help all farms regardless of where they are located on the income spectrum.

How big is the spread? He quickly puts the issue in perspective. The differences within any farm sector, he says, are greater than the differences between sectors.

A quick glance ahead to the bottom line of Table 1 (below) helps confirm it with the latest numbers from a study of grain and oilseed farms in Ontario and Manitoba, based on five-year histories of actual commercial operations.

photo: File

Before the capital costs of land and machinery are factored in, essentially all farms in that study were making money, although that gap between them was startling enough.

After all their operating costs were paid, the most profitable 25 per cent of farms retained 48.5 per cent of their market income. Average farms retained 34.5 per cent, and the least profitable 25 per cent were left with just 11.1 per cent.

“I’m pretty sure I know which one is in a better position to bid on a local farm,” Martin says.

But there’s another surprise. Performance has little to do with size, age, or any other specific factor. Some large farms score very highly on financial performance, Martin says. Others are a mess.

“It’s hard to generalize,” he says. “Maybe I should say almost impossible.”

Not surprisingly, that makes it even harder for farmers to know how their farm compares with other farms across the industry.

Martin points to a test he ran with 2015 numbers from three roughly comparable farms in the study. Farm A had $1.58 million in sales and generated net earnings of $320,000, Farm B had $1.64 million in sales with a net of $131,000. Farm C had sales of $1.43 million, and it lost $229,000 on the year.

On approximately $1.5 million in sales, in other words, there was a spread of over $500,000 in net income, and Martin says it’s what’s happening in every sector and every neighbourhood.

Lisa Kemp, ag partner for BDO at Lindsay, Ont., finds the results don’t come as a complete shock to the farmers in the study. She also notes that sometimes there can be partial explanations. Young and mid-career farmers may be pushing growth and carrying more debt than they know is ideal, and older farmers may be coasting and less concerned if the comfortable new tractor is completely justifiable.

That said, even those farmers can’t really know where they are in the pack, and whether they’re in potential danger, Kemp says.

“This is a good reality check,” Kemp says of the benchmarking process. “It’s very easy to blame external factors… It’s good for people to see what their peers are doing. It creates a point of opportunity.”

Standardized financial benchmarks

The “this” that BDO is working on with Martin and with Joerg Zimmermann, principal of GlobalAgAdvisors, is just what the name suggests. The objective is to develop a series of benchmarks for a farm’s financial management that are as precise as the benchmarks that farmers use for setting targets in the field or in the barn.

Martin started work on the project with colleagues while still on Guelph’s faculty. That’s back when detailed numbers were available from Statistics Canada. Now, he thinks the need is even more pressing.

It’s an issue that has come up repeatedly with his CTEAM classes, with farmers from multiple sectors across the country who come to know their financial statements backwards and forwards, but are left unsure whether their farm is actually successful.

To know that, they have to have a sense of how they are doing in comparison to others, so they can see whether they’re capturing what’s possible to be captured.In other words, if half of farmers are doing better than them on a particular line item, it probably means there’s room for them to improve. If only five per cent are better, they can probably only expect modest ongoing gains in that category, and need to look elsewhere for big scores.

It’s critical to emphasize that this work depends on definitions. How exactly do you define Gross Margins? Does land rent get entered as a cash cost or as a capital expense? Much of the early work that Martin and Zimmerman did focuses on those definitions, leading to a field test with 78 farmers in 2017, followed by more detailed work with BDO and field testing with five-year data from 500 BDO clients in 2018, with a focus on developing benchmarks in Ontario and Manitoba for grain and oilseed producers and also for milk producers, although the process also has cross-sector applicability.

Kemp sees the project as a major step ahead for farm management. When asked what she would have used for benchmarking clients’ results in past, she says, “Honestly, nothing. We didn’t rely on benchmarks.”

Some BDO branches would generate an average Contribution Margin or Gross Margin, and use that as an indication of individual farm performance. But a five-year, detailed benchmarking system was just not on their radar.

Now she looks at standardized financial benchmarks as a key to understanding farm financial performance.

Comparing your results

Conceptually, the benchmarking system starts with the idea that it is possible to separate a farm’s operating costs from the cost of accessing the capital (i.e. land and machinery) needed for production.

The full report will soon be released, and more details will also be available as Country Guide follows up on the benchmarking system this fall, but for now, it’s important to see that the system breaks the operations costs into three categories. See Table 2 (below) for a rough schematic.

*The above is simplified in order to indicate how the Standardized Financial Benchmarking system works. For specifics it is important to consult report details. For a brief definition of the five steps named here, go to the bottom of this article.
photo: File

The calculations start with Revenue, representing sales generated from marketable production and changes in inventory. It doesn’t include off-farm income, other investments or other income sources because the objective is to assess the farm’s production performance and efficiency.

By subtracting Cost of Goods Sold, ie. the cost of field or barn inputs, the system generates Gross Margin. As a rule, this should be in the 65 per cent area, meaning the farming is producing about $3 worth of crop, for instance, for every dollar spent in the field.

When the cost of the labour and the cost of operating the machinery used to produce those sales is deducted, the result is the Contribution Margin. Then, finally, when the Operating Overheads, including marketing costs, office costs and administrative expenses are subtracted, the farm’s Operating Efficiency is revealed.

(Again, this is an overview. Do check the details.)

Capital Costs and Interest are then subtracted to produce Net Income Before Taxes.

What’s to gain?

The key is that the numbers are aggregated, creating benchmarks for everything from large ratios to individual line items ranging from electricity costs to equipment depreciation, with the intention of making it possible for farms to compare their finanial performance against the industry.

BDO senior accountant at Portage la Prairie, Carol Kruck, sees benefits for farmers both in identifying and then in attacking specific problem costs, and also in addressing more strategic questions.

Often, the first impulse is to look for ways to cut any cost that seems a problem. Yet there’s another option that deserves consideration. It’s to generate more income from the cost. As a simple example, a farm with a high labour cost might look at more ways the employee can add value rather than cutting their hours. Ditto for machinery costs.

The ability to zone in on specific areas is important, Kemp agrees from her Ontario office. Typically, when they run a farm’s numbers, one or two costs will pop up, sometimes more.

Then they can drill down, often analyzing how that farm has been trending for that category over past years.

Then the thinking starts to broaden, Kruck says, and soon the results get used to run scenarios and do future planning.

Again, Kemp’s experience is similar. “We’re having those conversations now,” she says.

Many of the implications, however, are attitudinal. Kruck and Kemp say the analysis has been encouraging for farmers who know they’ve had ground to make up but haven’t been sure how to start. They also find that in a multigenerational context, the benchmark analysis leads to talk about new opportunities, inspiring conversations about scale of operations, and getting the younger generation thinking in concrete terms about long-term objectives in connection with next steps.

Martin sees the reports helping a broad cross-section of farmers think about their own leadership as well. Successful farmers, he says, tend to be detail oriented, and they’re attracted to problems like trying to cut a specific cost by a specific percentage.

But agriculture will find it takes more to get to the next level. “If you’re happy with three to five per cent,” Martin says, “you’re going to disappear. The world is going to change.”

The farmers who will make the best use of the 2020s, he says, are the farmers he’s already beginning to see, combining a shrewd attention to detail with an open-minded and innovative approach to their careers, regardless of their size.

“These are the farmers who are always looking for new opportunities, always looking at the research, looking for different kinds of business, for a whole new way of capturing more margin.

“They’re always sharpening the saw,” Martin says. “They amaze me.”


Step 1: Revenue from Farming
This is income from farm production, i.e. sales, and changes in crop or livestock inventories. Because the goal is to look at farm performance, it also includes crop insurance payments, but excludes other government payments or non-farm work or investments.

Step 2: Gross Margin
Gross Margin is Revenue minus the Costs of Goods Sold, i.e. the cost of the production inputs you purchase to produce that revenue. In a crop scenario, for instance, this includes seed, fertilizer and crop protectants as well as crop insurance, but it does not include labour or machinery costs. Importantly, this does not include land rental costs.

Step 3: Contribution Margin
Direct Operating Expenses include labour costs used to produce the goods being sold (i.e. not the labour used for overall farm management), plus the cost to operate machinery in the actual production of the goods sold, plus similar costs for custom work and repairs and maintenance. Subtracting Direct Operating Expenses from Gross Margin produces Contribution Margin.

Step 4: Operating Overheads
Operating Overheads include non-production costs such as administrative costs, office expenses, professional fees and insurance. Subtracting these from Contribution Margin gives Earnings prior to Cost of Capital. Importantly, when this is expressed as a percentage of your Revenue, it produces your Operating Efficiency Ratio.

Step 5: Cost of Capital
This is your annual cost of accessing the capital assets required for production. It includes the capital of machinery, equipment and land, including rent. It also includes depreciation on buildings and machinery. Different accountants report such costs differently, so it may take some analysis to ascertain this figure for your farm.

About the author

Editor

Tom Button is editor of Country Guide magazine.

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