A financial analysis of your farm can be very helpful especially during a time such as recent years when farming economy has taken a hit.
The past several years have seen some tough times for Michigan farms. Challenges ranging from high ending stocks to impacts from foreign trade that have caused lower prices across most commodities. These low prices have resulted in low farm profits, making it difficult to cover cash flow needs and limiting growth for many farm businesses. The level of these impacts has varied widely between farm types and individual farms; making understanding individual farm trends extremely important to future success.
Many of Michigan’s farms are continually asking the question, “how can we continue to weather through this difficult economy?”
MSU Extension recommends performing an annual financial analysis of the farm business. It provides an in-depth look at where the operation is financially and helps to define what the options are to moving forward. Comparing that analysis to other farms can help further define what options make the most sense for your farm.
The 2018 Michigan Farm Business Summary report (https://www.canr.msu.edu/resources/2018-farm-business-analysis-summary-report) from MSU Extension and MSU Telfarm Program is a collection of individual in-depth farm analyses from all across Michigan. It provides individual operations a means of comparison against other farms in similar industry and farm size.
For example, the 2018 season saw the trend of economic challenges starting to show greater impacts on Michigan farms. Profits in the year fell to an average of $49,912 (in comparison to $88,196 in 2017), resulting in a negative cash flow margin of -$76,817 (margin in 2017 was -$43,204). The average farm saw a decrease in working capital by a similar amount to the cash flow margin; indicating that cash from the operation (not revenues) had to be used to pay debt. A continuing trend seen across Michigan farms since 2016.
As you think about your farm’s situation, how is it trending in comparison to the benchmark farm?
Table 1. Farm Financial Performance Measures from MSU Extension Telfarm Program Benchmarking
| | Average across all farms | | The middle 2/3 of all farms | | Vulnerable values |
| 2017 | | 2018 | | | | |
Dairy Farms | | | | | | | |
| | | | | | | | |
Current Ratio | 2.0% | | 2.0% | | 0.9% to 6.0% | | 1.3% |
Working Capital to Gross Income | 18.6% | | 18.6% | | -4.3% to 36% | | 12% |
Rate of Return on Farm Assets at valued at cost | 1.50% | | -1.80% | | -5.5% to 1.5% | | Less than interest rate on borrowed funds |
Farm Debt to Asset Ratio | 29.0% | | 28.0% | | 10% to 45% | | 60.0% |
Replacement Margin | $30,734 | | $192,271 | | | | Negative |
| | | | | | | | |
Crop Farms | | | | | | | |
| | | | | | | | |
Current Ratio | 2.1% | | 2.0% | | 0.8% to 7.8% | | 1.3% |
Working Capital to Gross Income | 36.5% | | 33.7% | | 11% to 93% | | 11.0% |
Rate of Return on Farm Assets at valued at cost | 1.7% | | 2.8% | | -0.6% to 4.7% | | Less than interest rate on borrowed funds |
Farm Debt to Asset Ratio | 26.0% | | 26.0% | | 2% to 37% | | 60.0% |
Replacement Margin | $44,737 | | $10,987 | | | | Negative |
For those in the dairy industry, a period of multi-year low profits and concerning working capital is not a new situation. In 2018, the situation worsened for dairy farms as the average farm losses plummeted to -$38,078 and cash flow deficiencies grew to -$192,271. This led some farms to determine it was time to exit or focusing on switching to enterprises other than dairy.
One enterprise of interest to many dairy farmers is the grain industry, as it fared better during the same multi-year period. Profits steadily increased from an average of $23,585 in 2015 to upwards of $144,619 in 2018. However, cash flow considerations show that the $10,987 reported in 2018 is the first positive margin in the last five years (-$44,737 in 2017). This indicates that grain farms were not immune to the economic struggles and may or may not be an answer for individual farms looking to switch enterprises. This is where the importance and benefit of an individual financial analysis of your farm is key.
A financial analysis also provides an opportunity to dig deeper and consider cost of production or analyses on the farm’s different crop or livestock enterprises. It allows operations within the same industry type (i.e. dairy, grain, etc.) to see what makes similar farms successful and understand where efforts to improve could begin. For example, the average cost of feed per cow in 2017 was $2,623 per cow. Comparing to the top 25% of the group saw a reduction to $2,042; a difference of almost $600 per cow. For a farm that has average feed expenses, are there possible steps they can take to reach similar cost savings?
Finally, the financial analysis can help you determine how profitable the farm business is when considering borrowed debt. For instance, in 2018 the average rate of return on assets for grain farms was 2.8%. A farm’s rate of return on assets should be greater than the average interest rate on borrowed capital, so that interest is not eroding away the value of the farms assets. If the average interest rate on farm debt is 5%, then the business was not considered profitable in 2018 because all of the profits went towards paying interest.
There is an old saying, “Before you can see where you’re going, you have to know where you’ve been.”