Currently available farm management software and data capture equipment make it possible for farmers to collect huge quantities of data. The requirements for VAT and diesel rebates have also forced them to keep highly accurate financial records. In turn, this means lots of opportunities for generating numerous reports. Invariably, these are intended to highlight efficiency measures, usually expressing some variable in terms of another variable – what KZN agricultural consultant Allan Penderis calls the ‘pers’: per cow, per hectare, per whatever.
In most cases, these reports are carefully filed or even shredded. In a few cases, the data is analysed and used as basis for financial and physical management decisions on the farm. But, in general, you find that, without a systematic approach to the analysis of efficiency and financial measures, farmers frequently take wrong decisions. It’s especially important to begin any analysis with a wide-angle view and not myopic introspection.
Farmers frequently get bogged down in analysis, but higher ‘pers’ such as yield per hectare, yield per cow, cost per kilogram of meat produced and all the others you can think of, do not necessarily contribute to profitability. The first step in evaluating a farm’s profitability and efficiency is determining the farmer’s goals. You can then analyse the farm’s performance in terms of the achievement of these goals. And to analyse a farm’s performance, you need to look at its financial situation.
The goal is to increase wealth. Wealth creation means the net worth of the business must increase from year to year. If the total value of assets increases, but total debt increases more, net worth will decrease. Currently, with inflation running at about 6%, a 6% increase in net worth/year means the farm is just keeping pace with inflation. A high growth rate, especially if sustained over a couple of years, shows that the farmer is probably doing most things right.
The financial health of a farm is evaluated in terms of its solvency, its ability to service short-term debt (liquidity) and its ability to manage financial risks. Solvency is the ratio between total assets and total liabilities. But a farmer who runs a very profitable business can manage higher debt ratios than a farmer with a lower rate of return. As a rough rule of thumb, most financial institutions prefer a ratio of assets to liabilities of 2:1 or better. If this ratio worsens during a year, it doesn’t necessarily mean the business’ financial situation has deteriorated. It might simply mean the farmer has made a large capital investment.
For farmers with seasonal income, a liquidity ratio is generally worthless as it varies hugely from one month to the next. A better indication of liquidity is found in the farm’s cash flow statement. The net cash flow ought to be positive. Ensure that you include all expenses, including drawings, interest and capital repayments in your cash flow statement.
After the financial evaluation, the next step is determining profitability. Before you check on the profitability of individual enterprises, evaluate total farm profitability. Total expenditure and income are used here. Do this on a total farm basis and not on a ‘per whatever’ basis.
The evaluation of total farm profitability and farm financial performance forms the backbone of farm decision-making. Carefully examine fixed cost items and see if you can limit fixed costs. Compare with previous years’ historical figures and explain the differences. Also compare actual results with budgeted amounts and determine the reasons for deviations.
After carefully studying the big picture, a farmer can use efficiency measures – all those ‘pers’ generated by the computer programmes to evaluate the profitability and efficiency of individual enterprises in detail. But before taking any decision based on one of these measures, go back to the total farm budget and see what the impact of this decision is on the total farm.
For example, it’s easy to increase yield/animal by selling some lower-producing animals, but in many cases the higher-producing animals left over don’t produce enough income to cover all farm costs. In summary, a farm is a living system and should be evaluated as such. While efficiency measures may provide information on the efficiency of individual enterprises, these should never become a farm goal and all decisions must be evaluated on a total farm basis.
Dr Koos Coetzee is an agricultural economist at the MPO. All opinions expressed are his own and don’t reflect MPO policy. Contact Dr Coetzee at [email protected]. Please state ‘Global farming’ in the subject line of your email.