Farmers measure production, income and profits – Avoid Distress

Ever increasing farm production still leaves farmer’s distressed

Farmer distress, inability to meet debt repayment, constant government loan waivers and low income from produce are almost a constant matter of debate and discussion these days.  Our farmers are producing ever more from their lands and yet ever more lagging in lifestyle standards.  This article discusses physically measuring the reasons for such a sorry state of affairs.   We discuss using the following parameters of a farm to bring insight into what needs to be done.

1. Liquidity of one’s farm business,
2. Solvency of farm business,
3. Profitability
4. Repayment capacity of the farmer, and
5. The financial efficiency of the operations.

LIQUIDITY

1. Ability of your farm business to meet financial obligations as they come due, and,
2. Generate enough cash to pay your family’s living expenses and taxes, and make debt payments on time.

How will a farmer know, mathematically, whether his business of farming is solid and has enough liquidity to meet any challenges?  For this, he needs to know his total debt, his total assets which could be partly owned by banks and lenders, and partly by him. Let us break it down even further to understand the liquidity of his farm business.  The following ratios illustrate the situation:

1. Debt on the farmer to farmer’s asset ratio:  Higher ratio indicates higher financial risk and lower borrowing ability.
2. Equity to Asset ratio. In case the farmer has mortgaged his assets to lenders, his own equity is reduced.  Lower ratios are a warning signal to farmers to pay off mortgages or else lose out on their assets.
3. The current assets to current liabilities ratio: should be greater than 1 as then in case of circumstances if the farmer has to sell his assets he is in a position to completely pay off his liabilities.

SOLVENCY

1. It is the ability of a farmer’s business to pay all its debts if it were sold tomorrow.
2. Solvency is important in evaluating the financial risk and borrowing capacity of the business.
3. A SOLVENT FARMER HAS GREAT PEACE OF MIND. He knows he has nothing to worry and he can easily repay all loans and redeem any and all mortgages on his assets.

PROFITABILITY

1. Is the difference between the value of farm produce and the cost of the resources used in their production.

Simply put farmers produced say wheat at what cost (labor, seeds, fertilizers, insecticides, machinery, his own time as money value, etc.).  The following ratios provide instantaneous insight into whether the farm business is really profitable to him.

1. Net Farm Income:  This is Gross cash received from product minus total cash expenses plus any inventory costs etc. Farmer’s unpaid labor management is paid out of this income. So look out if you are getting sufficient income for you and your family members who manage the farm.
2. Rate of return on farm equity:  we calculate this as net farm income generated by the farm minus the cost of operating labor and management divided by average farm net worth. A farmer may well ask is he getting an interest rate on his investment had he parked the same somewhere else?  A rule of thumb is that it should ideally be greater than 3%.
3. Operating profit margin:  One needs to keep expenses low relative to the value of farm production.  Farmers would get a lower profit margin in case:  (1) product price is lower than estimated, (2) expenses are high, and (3) inefficient production practices are being followed.

REPAYMENT CAPACITY

Repayment Capacity refers to Farmer’s ability to meet deadlines on his installments regularly on time.  This ability may be partly due to farm production and partly due to other income of the farmer.  So in reality this is not to be considered a performance parameter of a farm.

The one paramount consideration here is the ratio of total income to total debts (principal and interest) plus any capital replacement costs.

FINANCIAL EFFICIENCY

1. It is how effectively your farm uses assets to generate income. Financial Efficiency also throws light on:
   1. How well every available asset is utilised to its fullest potential.
   1. Effect of farmer’s decision on production, purchase, pricing, financing, and marketing decisions.

Prime ways to find out the efficiency of operations on a farm are:

1. How well do you utilize your farm assets to generate income? This ratio is calculated as the total value of farm production divided by the value of average farm assets.  One may aim at more than 30% for this ratio. Should the farm income be lower the farmer has to consider more methods of utilizing his assets OR may be selling off some low return capital assets?
2. Another way to measure farm efficiency is by the Operating Expense Ratio. This ratio is calculated by dividing the total farm operating expenses excluding interest and depreciation by gross farm income.  Needs to be a low value maybe around 50% (but this is subjective, who would not want something for nothing).
3. Another interesting ratio would be gross farm income divided by all farm interests.  So if the farmer has no interest to pay, he has a 100% ratio!!

You may like to read our blog on wheat farming.

Example of wheat production

Let us take an example of wheat production per acre.  It is a known fact that the production of wheat varies from region to region and sometimes within a region as well. Contributory factors for this disparity are the availability of:

1. irrigation facilities,
2. fertilizers and chemicals,
3. labor,
4. machinery,
5. electricity,
6. good seeds and
7. wayward weather.

Production/acre of wheat is very loosely coupled with the size of the farm. What larger size obtains is a much higher return in cash value.

For our example, we assume Production/acre = 15 quintals and the following values of costs per acre for variables.

Total sales: 15 x 2000 = 30000

Net farm income = 30000 – 11500 = 18500.  This amount is what is left to him as his and his family’s labor in the production of wheat per acre.

Operating expense ratio =   operating costs including interests / gross farm income

                                    = 11500/30000 app. 38% (no interest cost here)

Rate of return on farm equity: A farmer may well ask if he is getting an interest rate on his investment had he parked the same somewhere else.  The rule of thumb is that it should ideally be greater than 3%.  Let us assume a general Rs. 5,00,000 value per acre of the land plus building plus machinery. We got a net farm income in this example of Rs. 18,500.

Rate of return on farmer equity is 18500/500000 * 100 percent = 3.7 percent.

(O.K. this is just an example, the value of land, building, and machinery may be more, could be less also, so the percent rate of return would vary.)

Notes:

1. Current Assets—Current assets are cash or items that can be easily converted to cash in one year or less. Common current assets include cash, savings, prepaid expenses, growing crops, harvested crop inventories, market livestock, accounts receivable, seed, feed, fertilizer, and other supplies on hand
2. Current Liabilities: Accrued interest, accounts payable (bills), credit card balances, short-term operating, and principal due within 1 year on non-current loans.

About nkp

Hi ; I have had opportunity to travel widely and have keen watched whatever farming practices the local farmers were engaged in. Back home been growing gerberas mostly in polyhouses, but outside in kitchen garden as well. i love these hardy perennials. good for business too if done in a routine orderly scientific manner. Also engaged in farming of wheat and organic vegetables on a small scale for me and family. My service profile has been that of an electronic and telecom engineer and now am engaged in web site creation and blogging.