Benchmarking for better decisions: Understanding farm financial statements

September 24, 2019

NTL_Agricutlure-FS_12Aug19_Financial-Statements_LandingPage_679x220.jpg

Never before has strong farm financial management been more important than it is today. Or as challenging. In addition to planning and monitoring all the moving parts of a farm’s operations, knowing where you stand financially equips you to make the most informed business decisions for your farm to flourish. The basis of determining this positioning lies in your financial statement analysis.

BDO’s team of agriculture accountants have standardized the farm financial statement to serve farmers’ best interests. Efforts to streamline this process allowed us to develop a set of financial benchmarks as a way for clients to compare their results year over year to plan better for the future based on specific areas of focus. This is information you can trust to make informed decisions, as it’s structured to help you understand and compare the areas most applicable to your farm.

Benchmarking against results

What is benchmarking? It’s the process of evaluating something against a standardized comparison. Our financial benchmarking package for farm management looks at financial results over five years along with data from a regional client base.

BDO’s financial benchmarking package was developed as a management tool to provide guidance that supports financial statement analysis. Data is only as valuable as the decisions it enables. This is why our team strives to deliver the most relevant data that supports strategic future planning.

Once a benchmark is chosen for analysis, data is extracted to show results. Information is presented in charts with a chosen benchmark trend line to show the comparison. All charts can be shown as a percentage comparison, dollar per head, dollar per kilogram of yield, or as a dollar-to-dollar comparison.

Understanding the farm financial statement

Originally, Dr. Larry Martin created the standardized statements as a way to do analysis for his CTEAM program at Agri-Food Management Excellence—comparable to a mini MBA program for Canadian farmers. He organized the farm financial statement on two principles:

  1. Managing operations is different from managing capital and finances, so it’s organized to reflect those areas independently
  2. All farms, no matter what commodities they produce, have five standard sets of costs

Items included as farm revenue

Includes:

  • Sales from farm production
  • Gains/losses from legitimate hedging programs
  • Crop insurance payments
  • Revenue

Does not include:

  • Government program payments (except crop insurance)
  • Earnings on investments
  • Gains/losses on disposals
  • Off-farm work
  • Other non-farm income

Cost category breakdown for financial statements

The five cost categories for farm financial statements are segmented within two types of costs:

Operating Costs

1) Cost of goods sold
2) Direct operating expenses
3) Overhead expenses

Financing Costs

4) Capital related costs​
5) Interest

Operating costs are based on the nature of agricultural production. This production encompasses converting raw materials into final products and using labour and equipment to produce and transport inputs and products.

Financing costs account for the annual cost of capital and interest.

1) Cost of goods sold: Items farms buy to transform initial inputs into intermediate and final products. Examples include converting seeds, with the help of fertilizer, pesticides, etc. into forage, grain, and produce. With livestock, this consists of transforming offspring of parent animals, with the help of feed, medicines, etc. into meat, eggs, or dairy products.

2) Direct operating expenses: Costs associated with activities directly involved in operations. These expenses include operational labour, fuel, custom work, repairs and maintenance, utilities, small tools and supplies, and transportation costs.

3) Overhead expenses: Also referred to as fixed costs; costs not directly related to production and transportation. These include office and administrative expenses, advertising and promotion, staff salaries, insurance, and professional fees.

4) Capital related costs: Also known as depreciation/amortization/financing; costs of accessing capital assets like machinery, land, buildings and quota. Capital related costs include the depreciation and amortization of machinery and buildings, leasing and rental costs of capital assets, land clearing costs, and property taxes.

5) Interest: Interest on short- and long-term financing. We include gains/losses on sales of capital or investments in the ‘other income and expenses’ section of the financial statement. This part of the statement does not include bank charges.

How to apply cost categories as benchmarks

Each cost category can be analysed and treated as a benchmark for comparison. Farmers can choose to compare results with their own data year over year, or with regional benchmarks and their associated five-year averages. These comparisons give a practical view into what their numbers look like and how they should look to maintain a successful progression.

A higher percentage or dollars per acre spent in certain categories can indicate areas where further analysis is required. This analysis creates an opportunity for discussion and is where our team steps in to offer guidance. This is also an opportunity to identify red flags, if they exist, and to take the necessary steps to bring things back to a steady and profitable state.

Let’s use an example to demonstrate how using contribution margin per acre as a benchmark can help determine whether a land purchase could be profitable:

Farm X is a 1,500-acre farm, growing grain and oilseeds. Let’s assume average land cost is $3,600 per acre with a 4% loan interest rate. If we were to add 350 more acres without any additional equipment or labour, how could that increase income?
Before additional acreage
Contribution margin of 1,500 acres @ $252/acre $378,000
Fixed overhead costs -$74,500
Fixed capital costs -$270,000
Income Before Other Items and Taxes $33,500
After adding 350 acres of land
Contribution margin of 1,850 acres @ $252/acre $466,200
Fixed overhead costs -$74,500
Fixed capital costs -$270,000
Increase in interest: $1,260,000 @ 4% -$50,400
Income Before Other Items and Taxes $71,300
Increase of Income Before Other Items and Taxes $37,800

Looking at a fixed contribution margin per acre as the above example benchmark, we see the additional land purchase could increase income by $37,800 per year on those parameters alone. This tool has the potential to show how making improvements, no matter how small, can impact a farm’s financial strength. Our team of advisors can discuss the potential changes your farm can make to benefit your financial health or improve operational efficiency.

How benchmarks and standardized statements can help your farm grow

You can’t manage what you don’t measure. Whether you’ve recently transitioned into a farming operation or have been running your family farm for generations, our standardized farm financial statement and benchmarking package can help gauge your position and suggest improvements. Our team would be happy to discuss this with you and answer any additional questions.

Further to the financial statement overview, you can download our full report, Benchmarking for Better Decisions.

You can’t manage what you don’t measure. – Mark Verwey, National Agriculture Leader