Farm Size: Am I Big Enough?

1
Farm Size Am I Big Enough?
2
Objectives

• Establish criteria for how big a business should
  be
• Estimate minimum viable size by assessing owners
  need for income
• Understand relationship between financial growth
  and earned income

3
How Big Should the Business Be?

• The business is big enough when
• Internal Dimension
• It is low cost economies of size

4
Economies of Size
The Farmer
5
How Big Should the Business Be?

• The business is big enough when
• Internal Dimension
• It is low cost economies of size
• It meets its operators needs for income
  minimum viable size from family income needs
  perspective
• External Dimension
• Its size permits access to markets, information,
  and competitive technologies minimum viable
  size from industry perspective

6
Income Needs Analysis

• What is the minimum amount of net income that
  will satisfy operators needs?
• What gross income would normally be required to
  produce this much net income?
• How much investment (financial assets) would
  normally be required to produce this much gross
  income?

7
Part I. Income Needs Analysis
Spendable Income Needs Forecast
A. Family living expense
B. Term debt service (principal only)
C. Carryover debts (principal only)
D. Income and self employment taxes
E. Reinvestment in the farm business
F. Saving for retirement, college, etc.
G. Other wants/needs
H. Total income needed
I. Less non-farm income available
J. Income needed from the farm
8
Part I. Income Needs Analysis
Spendable Income Needs Forecast
A. Family living expense 150,000
B. Term debt service (principal only) 91,648
C. Carryover debts (principal only) 0
D. Income and self employment taxes 0
E. Reinvestment in the farm business 71,234
F. Saving for retirement, college, etc. 30,000
G. Other wants/needs 0
H. Total income needed 342,882
I. Less non-farm income available 20,000
J. Income needed from the farm 322,882
9
Part II Income Needs Analysis Historical
Performance
K. Net Farm Income from Operations Ratio K. Net Farm Income from Operations Ratio
Net Farm Income
divided by Gross Farm Revenues
NFIFO

L. Asset Turnover Ratio
Gross Farm Revenues
divided by Total Farm Assets
Asset Turnover Ratio
10
Part II Income Needs Analysis Historical
Performance
K. Net Farm Income from Operations Ratio K. Net Farm Income from Operations Ratio
Net Farm Income 280,519
divided by Gross Farm Revenues 1,796,651
NFIFO 0.156

L. Asset Turnover Ratio
Gross Farm Revenues 1,796,651
divided by Total Farm Assets 4,655,476
Asset Turnover Ratio 0.386
11
Part II Income Needs Analysis Results
M. Gross farm revenues required to generate needed spendable income M. Gross farm revenues required to generate needed spendable income
Total Income Needed (J)
divided by NFIFO (K)


N. Assets required to generate gross revenue N. Assets required to generate gross revenue
Required Gross Revenues (M)
divided by Asset Turnover Ratio (L)

12
Part II Income Needs Analysis Results
M. Gross farm revenues required to generate needed spendable income M. Gross farm revenues required to generate needed spendable income
Total Income needed (J) (from Part I.) 322,882
divided by NFIFO (K) 0.156
2,069,756

N. Assets required to generate gross revenue N. Assets required to generate gross revenue
Required Gross Revenues (M) 2,069,756
divided by Asset Turnover Ratio (L) 0.386
5,362,062
13
More Spendable Income From the Farm Without
Getting Bigger

• Increase NFIFO Ratio
• Reduce costs
• Outsource
• Increase Asset Turnover Ratio
• Increase prices or output
• Reduce investment

14
Can the Business Grow?

• Growth is dependent on
• Identifying opportunities for profitable
  expansion
• Acquiring resources to implement expansion

15
Two Behaviors Critical to Internally Funded Growth

• Earnings behavior
• Savings behavior

16
Leverage and Growth

• In the short run, a farm can growing by
  borrowing, the potential to grow with debt
  capital is limited by earnings and assets
• Earnings leverage growth, as well as fuel it
  directly
• Appreciation in capital asset values may increase
  borrowing ability, but wont increase the ability
  to service debt
• Financial performance should be monitored
  annually using cost value ROA versus ROE (ROE
  should exceed ROA) and SGR trend

17
Profitability, Size, and Growth are Interdependent
Profitability
Size
Growth
Business Control Panel

• Which button do we push to achieve
  competitiveness?
• Profitability
• Size
• Growth
• All of the above

18
How Would You Respond?

• First scenario The farms asset turnover ratio
  is 18, when 38 would be typical for average
  competitors. The operating profit margin ratio
  is 12. The farm has no debt and substantial
  equity, but little cash.
• A. Improve performance
• B. Expand operation

19
How Would You Respond?

• Second Scenario The farms asset turnover ratio
  is a remarkable 50. The farms operating profit
  margin ratio is 5. The farm has little or no
  debt, but little cash.
• A. Improve performance
• B. Expand operation
• Should a manager ever consider expanding an
  unprofitable business?

20
Summary - Keys to Achieving a High Sustainable
Growth Rate

• High profit
• Retention of income as opposed to distributing
  income to owners
• Optimum leverage
• Outside equity capital
• Strategic fit with industry scale

21
Strategic Business Planning for Commercial
Producers