As someone who helps producers financially plan for their farms, this question might cause uncertainty with my credentials. It is a valid question that needs to be asked.
There are many answers to the question: can we plan to lose money? One answer is, not every year. Sometimes in business there are times when you have to prepare to go through the entire year knowing it will not be profitable.
It is important to distinguish a few terms regarding making money. The Income Tax Act defines profit as income left over after eligible expenses. As an agriculture financial adviser, I am not interested in your farm’s profit. I want to know if there is money left over after all of the obligations are paid. Some of these obligations do not affect your profit but they do affect your farm. When I measure the financial performance of a farm, we look at all the money that leaves your bank account. Not only do we look at common expenses like fertilizer, chemical, seed, fuel, feed and veterinarian fees, we also look at equipment payments, land payments, personal drawings and agreement for sale arrangements with family. Any expenditure that relies on the farm is included.
Looking at 2018, there is a chance that some farms in Western Canada will have more money leave their bank account than the farm will produce. If we look at the crop guide for Saskatchewan for 2018, there are more negative returns than positive. The Ministry of Agriculture looks at 15 crops. Of these, six show they will produce enough cash to cover all costs where nine will not. This reasonably negative look at our industry is not new. Almost every year there are more losers than winners in this publication. What concerns me about the financial analysis in the 2018 guide is that even though the numbers are pessimistic, the income projections are overly optimistic based on current moisture trends. The prices for production seem realistic. The yields also seem realistic, but we will need more moisture in my area than we received this year to achieve them.
All of the producers I deal with are worried for 2018. Saskatchewan received less-than-normal rainfall for our growing season last year. Excess subsoil moisture allowed for a surprisingly great crop in 2017. That will be impossible to pull off with the same amount of rainfall. Where I live, we received less than two inches of rain during the growing season. Moisture patterns have continued and we now have less than normal amounts of snow. We all know we can’t grow a crop on snow, but the fact remains that moisture patterns tend to continue from season to season.
What if production on farms falls below the cost to produce it in 2018? This is a question some farms will have to answer. I think it is important to put some aspects of the balance sheet in perspective.
We can be in a tough financial spot but not really be suffering. If you were in a workplace and you saw a co-worker eating a very frugal lunch, wearing the same clothes day after day, not participating in anything that requires money and generally being very poor, I am sure you would be concerned. Let’s assume you engaged in conversation with the co-worker and told them you were worried about their financial plight. The co-worker reveals to you that although they were earning a good salary of $1,800/biweekly net, they had decided to save $1,500 biweekly for their RRSP and TFSA so they could accelerate their wealth. So they only had $300/biweekly to try and live on. Would you feel sorry for this person?
I think all of us would feel that this unrealistic financial predicament was of their own making. We would not have a lot of sympathy for this person. This can sometimes be the financial situation on a farm. If you have excessive principal payments on assets, you are building wealth. And although this is an obligation the farm has to make, it is not the same as not being able to pay for fuel on your farm.
We need to take a look at what line items on our expenditures are production expenses and which ones are building wealth. I would argue that a principal payment on a combine is a true expense, but only to the extent of the loss of value on the combine. If you have a 10-year-old combine that you put 50 hours on each year, I would estimate the depreciation for that year is close to zero. If you have a two-year-old combine that you put 250 hours on, I would estimate the depreciation to be in the tens of thousands of dollars. You need to compare what the principal payment is on this asset as compared to depreciation. And let me clarify when I talk about depreciation: I am not speaking of a Canada Revenue Agency table, I am referring to the loss of true market value.
A perfect definition of an expenditure that builds wealth is the principal payment on land. That payment does have to be made in order for you to keep the land, but it also increases your wealth once you have made it. Another asset that follows this is cattle. This example is actually more exaggerated than land. Most lenders only allow for cattle to be financed over five years. This can lead to very high principal payments. There is an argument that each year the cow does lose some value but cattle producers would tell you that a cow should last longer than five calves. Most will last eight to 10 calves. Plus there is the natural retention factor that one of these calves will most likely be a heifer suitable for breeding thereby naturally replacing itself. So although the farm has a big cattle payment each year, it is actually building wealth.
So all of this brings me to one main recommendation: your operation needs to have sufficient working capital in case you run into a year where you spend more than you earn. Take a look at your current assets at the end of the year and your current liabilities. If you subtract the liabilities from the assets, what you have left is your working capital. This is the easiest way to fix a bad year.
The financial concept is that we are really just moving assets from one category to another. You take assets like cash, grain and market livestock and they get moved into longer-term assets like equipment, cows and land. This is the justification for planning for a loss on the farm. If you need to spend $1.5 million on your farm in 2018 and you only earn $1.3, the $200,000 can come from previous years’ cash excess that is built up in your working capital. Because some of the money will be going toward principal payments, your wealth is growing as your cash shrinks. Hopefully the rate will be the same so at the end of the year, your net worth is the same.
I realize it is easy to say you should just have a large amount of working capital. If your farm does not have sufficient working capital, consider making different decisions in years of prosperity. If you have cash left over at the end of the year, you have several choices for it. You need to prioritize where it goes. There will be demands to upgrade equipment and temptations to purchase land. You need to ensure your working capital is at an optimum level before you look at equipment or land. This is not a sexy option, but it is a very important part of the long-term success of the operation.
How you manage the risk of income loss is also part of this conversation. If you do not have sufficient working capital, or you do not wish to risk losing your working capital, do you know what options are out there? Do you participate in the Western Livestock Price Insurance Program? Do you participate in crop insurance? How much do you know about Global Ag Risk Solutions? All of these can help when we have production issues.
Having a strong knowledge of your financial situation will greatly improve your chance of survival in a tough year. You need to be able to determine what your cash shortfall might be and compare that to your working capital.