Most farmers choose to farm because they love animals, crops, being their own boss, or all of the above. It’s a way of life and a passion, but a farm is also a business that needs to be profitable.
“Producers are always thinking, when riding in the tractor, walking across the farmstead, or milking cows, about what can they be doing to make this farm more profitable, what can they do next to provide more business security,” said Kevin Bernhardt, a professor of agribusiness at the University of Wisconsin-Platteville and a University of Wisconsin-Extension farm management specialist. During a “Farm Management Fridays” webinar, he shared some tools that can help farmers analyze their profitability.
He said it all starts with the financial statements, more specifically the balance sheet and income statement. “There are a lot of neat tools, but you do need to have information from an accurate and complete balance sheet and an accrual income statement,” he said. “That’s a lot to do, just putting those financial statements together, but that’s where it starts. That’s the foundation.”
Once those financial statements are in order, Bernhardt said, “Ratios that can be calculated from the balance sheet start to tell a story about a farm. It can uncover where profitability is coming from, or what balls or chains are holding profitability back.”
One tool Berhhardt highlighted was the DuPont System for Financial Analysis. He said this is a great way to gain insight on three primary levers of profitability: working your assets, being efficient, and using leverage. “Every business has to have these three levers in order to make profits,” Bernhardt said.
It starts with using the assets you have, creating gross revenue from the cows, land, and tractors you already own. Bernhardt said this can be measured through the asset turnover ratio.
The next lever, being efficient, turns gross revenue into net income. This allows a farm to keep as much of the gross income as possible as profit. This is measured using the operating profit margin.
The final lever, using leverage, involves funding from a bank or another financial institution to make investments in the farm that will lead to more profitability.
Focusing on the first two levers, the asset turnover ratio multiplied by the operating profit margin can reveal a farm’s return on assets. Bernhardt said this is one of the primary metrics for profitability. A low return on assets can result from either a low asset turnover or low operating profit margin.
If the asset turnover ratio is low, a farm is not creating enough revenue for the number of assets or perhaps has too many assets. Areas of improvement could include improving conception rates, mortality rates, or feed conversion. Maybe there are price premiums or discounts that could be captured.
When too many assets are the problem, farms should determine if they have excess machinery or buildings that are not being utilized fully. Leasing versus owning land is another consideration, along with opportunities to share assets with other farms.
If efficiency is low, Bernhardt said a farm is spending too much to get those revenues. Practices to improve efficiency could be to minimize feed waste, reduce tillage, and fine tune animal health protocols, to name a few. Negotiating lower rental costs, locking in lower feed or seed costs, or seeking out opportunities to outsource tasks are a few other options.
“A lot of things can be done once we know it is expenses that we need to work on,” Bernhardt said. “It doesn’t often come back to one thing, but by identifying these areas, I now know where to spend my time.”
He continued, “I haven’t met any farmers who have too much time on their hands. The more you can pinpoint where you can get the biggest bang for the buck, the better.”
The author is the senior associate editor and covers animal health, dairy housing and equipment, and nutrient management. She grew up on a dairy farm near Plymouth, Wis., and previously served as a University of Wisconsin agricultural extension agent. She received a master’s degree from North Carolina State University and a bachelor’s from the University of Wisconsin-Madison.