If margins tighten as ag economists are warning, it’s going
to be important to consider the potential impacts on your operation. Making sure
that your farm is going to be financially healthy in what could be tougher times
may set you up in a good position.
Consider this: There were people who emerged as millionaires
from the Great Depression. How? They thought differently than the crowd during a
tough time — and their choices, based on that different thinking — landed them
in a much better position than the majority.
I also think of Warren Buffet’s advice: “Be fearful when
others are greedy and greedy when others are fearful.”
But first you need to know where your operation stands,
starting with what might be the most “basic” metrics for your business. I’ve
talked about working capital and equity here before, but this is a good time to
dust them off and use them as a lens for a fresh perspective on the current
situation in ag.
The first metric for your financial dashboard is working
capital. That’s your current assets minus current liabilities, divided by your
gross revenue. Your working capital shows you what’s available to reinvest in
We recommend working capital of at least 40 percent — while
most banks want to see around 15 percent to 20 percent. Why the difference? The
bank’s first concern is that you will be able to pay them back. Their next
concern is that you are financially healthy in the long-term.
We help our clients shoot for the higher percentage because
even if you have a tough year, you’d still be able to continue farming with that
larger cushion available. When you’re healthy financially, being able to pay the
bank back isn’t a problem.
If you recognize that your working capital isn’t as strong
as you’d like as we enter potentially tougher years, then you have the
opportunity to make different financial decisions based on that. Giving yourself
a cushion could make the difference between going out of business and being able
to take advantage of opportunities as they arise.
With tighter margins on the way, your working capital needs
to be strong. Otherwise, there’s no room for unanticipated problems — no margin
Everything would have to go exactly as planned. You couldn’t
afford to mess up at all.
The other metric that you need to be tracking, if you aren’t
already, is your equity to asset ratio. This is figured by taking your total
equity divided by your total assets.
It shows who owns more of your operation — you or your bank.
We want to see that at about 60 percent for our clients.
When you’re aware of this metric, you gain more leverage.
Healthy equity levels give you more power as you work with your bank because
it’s a better situation for all parties.
One thing to think about as you develop metrics for your
farm is to be careful what you measure because you get more of what you measure.
So you want to choose wisely as you think about what’s going to be most
important to measure on your farm in the coming years.
But how are we supposed to decide what to measure? We have
to make some choices around that. There’s just too much information available to
us now — too much data — and we can’t possibly go through all of it and use
everything that’s available.
The best metrics usually are simple to explain and easy to
figure out. They make up a helpful dashboard for your business.
What gauges on your dashboard do you need to focus on to
help you understand what’s going on in your business from a financial
Your term debt coverage ratio is another one that’s going to
become more important if farms run into tighter margins in the next few years.
It looks at your net income compared to your term debt payments.
For example, if your principal and interest payments are
$100,000 annually, then you’d want to have an accrual net income of around
You need to be able to cover 1.5 times your payments —
principal and interest combined – or, put another way, 150 percent. That would
be a healthy number for most farms.
Figure these metrics for your operation if you haven’t
already and track them over time. Knowing where you stand will help you make
good decisions and use your leverage to help your operation thrive during