By Dr. Mario Villarino, Hopkins County AgriLife Extension Agent, agriculture, natural resources
According to Texas A&M AgriLife Extension, financial sustainability of a business is measured by the ability to maintain equity and to generate a net after tax positive income and cover withdrawals for owner operator labor and management.
The reason withdrawals and distributions are important in evaluation of business sustainability is because frequently the ranch business must provide income for living withdrawals. Measuring the financial sustainability of a business does not require any new methodology since the business accrual adjusted financial statements clearly show historical financial sustainability.
The Farm Financial Standards methodology provides the guidelines for measuring equity change and return on investment (ROI) using the balance sheet and accrual adjusted income statement. At least 3 years of history and projected financial statements can provide information to evaluate future sustainability.
Projections are always limited by the ability to forecast future productivity and commodity prices. History is real but one can be misguided by past performance without realistic projections. Cash is king in the ranching business.
In the short run, cash income can be maintained by not replacing capital assets, called living on depreciation or not spending money on inputs like brush control and fertilizer. Remember, it is net after tax income that increases equity. For every equity dollar lost it will take $1.15 to $1.28 net income, depending on the tax rate, to earn equity back.
Ranch investment cash flow cannot service much debt or support large family withdrawals. This is why so few families make their living solely from ranching in the Southwest. There is no simple way to make this investment highly profitable when one looks at ROI.
Equity can be sustained by contributions from other business activities or salary earnings. However, to measure business financial sustainability, it is advisable to evaluate the ranch business then, consider the non-business earnings and oil and gas contribution.
The low rate of operating return on farm and ranch assets creates a major debt service challenge for borrowers. When producers make an investment, the returns generated should be greater than the cost (interest rate). In order to pay the cost of capital, the producer must use after tax return from equity or other sources of income to pay the difference between cost and earnings.
Ranches just have a very low repayment capacity and must avoid high leverage. The beef cattle industry is still often a predator or prey situation. It is wise to have the information to avoid being the prey. All this information improves the communication between decision makers.
“Let the numbers do the talking” is a challenge in the cattle industry as it is less common for cow-calf producers to manage by the numbers than any sector in agriculture. Any business decision that focuses on evaluations of alternatives needs to begin with a good set of “numbers” that clearly show the current situation and then present the numbers for alternatives. The users must understand the numbers so they really communicate.
In addition, as with any communication, the users must have confidence in the numbers. Communication has to take place in a timely manner before decisions are made. Closeouts from retained ownership are more important than projections. Actual cash flow means more than budgets. Accounting systems have to meet IRS reporting requirement, but can be organized in a way to provide the financial numbers that can used to develop accrual adjusted financial statements that communicate real financial performance. Calculation of return on investment (ROI) is critical in measuring the cow-calf sector – the investment phase in the beef cattle sector.
Opinions and talk without the numbers or mixing emotional reasons for doing things will not provide sound informed business management decisions. Talk is cheap when it is not backed by good accurate and timely numbers. Many ranchers and people around them are willing to express opinions with little information or understanding of the decision environment (historical or current situation).
Having good numbers is increasingly important for communication with family members, many with inadequate experience and information to judge performance. Likely the biggest treat ranchers have is often self-inflicted in that the ranch is not treated as a business.
Too much emphasis is placed on the lifestyle. If capital or off ranch, earnings are inadequate to support the family living and meet debt payments the business in not financially sustainable. Living within your means is a challenge in ranching. Too many ranchers wish to live the lifestyle of urban dwellers — an expensive goal in this world of high energy cost.
Inheritance tax places a major threat to ranch survival between generations. High rangeland values with assets that generate low earnings cannot pay high inheritance taxes. Transfers force breakup of properties that are inefficient and require outside earnings to be sustainable.
The ranching sector is increasingly challenged from a business perspective. To help understand private ranch economic scenario, Hopkins/Rains Farm Bureau has organized a “Ranch for Profit Workshop” seminar by Dave Pratt, one of the most sought-after and respected authorities on sustainable ranching in the U.S., on June 29, at the Hopkins County Regional Civic Center.
The seminar is free thanks to the generous support of sponsors: NETBIO, Northeast Texas Farmers CO-OP, Legacy Ag Credit and Texas A&M Agrilife Extension- Hopkins County.