March 5, 2010

Financial Benchmarking: Part 3

The last two columns discussed the pros and cons of financial benchmarking. This management tool can be used as a proactive measure for building a case for borrowing money for next year’s crops or growing the business. It is a useful tool for developing a business plan and sizing up overall economic performance. Now let’s discuss a financial benchmark that transcends the industry of agriculture.

Percent Equity: Total Equity/Total Assets

Percent equity basically tells you how much of the business you own versus the share creditors own. Believe it or not, the average in U.S. agriculture is approximately 90 percent equity. Do not be fooled by this number because approximately one-third of producers owe no money and this includes large and small farm businesses. A typical commercial farm or ranch business will have about 60 percent equity. Breaking it down further, the ratio will generally be higher for grain and cow-calf producers, and much lower for horticulture, dairy, poultry, feed lots, hogs, and younger farmer and ranchers.

When this ratio is less than 50 percent, it means the creditor owns more of the business than the producer, which causes flexibility and options to diminish. When this ratio is low, it requires strategic production, risk management, cost and expense management. Living withdrawals and dividends need to be below average for the agriculture industry, approximately $50,000 to $55,000 annually. In this case, a profit plan for building financial liquidity will be necessary in good years.

Comments

Please send your remarks to AgGlobeTrotter@accountlist.com. I would like to know what you are thinking.

Dr. David M. Kohl is Professor Emeritus of Agricultural Finance and Small Business Management and Entrepreneurship in the Department of Agricultural and Applied Economics at Virginia Polytechnic Institute and State University (Virginia Tech), Blacksburg, Virginia. Dr. Kohl has traveled over 5.1 million miles throughout his professional career. He has conducted more than 3,000 workshops and seminars for agricultural groups such as bankers, Farm Credit, FmHA, and regulators, as well as producer and agribusiness groups. He has published four books and over 400 articles on financial and business-related topics in journals, extension, and other popular publications. Dr. Kohl regularly writes for Farm Journal, Top Producer, Ag Lender, Journal of Agricultural Lending, and Soybean Digest.

©Northwest Farm Credit Services 2010

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