SuccessfulFarmBusinessStart Up:AFewIdeas

PaulDietmann,SaukCountyUW ExtensionAgriculturalAgent January,2006

KeyPoints
Itcanbedone! Itwilloftenbedifficult Startingpointwilllikelybemuchdifferentthan endingpoint Managingrisksiscritical
Somefactorsincreasechanceofsuccess Somecreatearecipefordisaster

Understandingandusingfinancialstatementswill putyoufaraheadofthepack

TheGoal

YouDONTNeed____toFarm
Toownafarm Dad,brother,grandma,richuncle Agovernmentgrant Abiglineofmachinery Abigpileofcashinthebank Abigpickuptruck

YouDoNeed
Opennesstodifferentideas Patience Timetoplan,analyze,replan Abilitytoswallowyourprideoccasionally Intestinalfortitudeduringtoughtimes Tocommunicatewithlenderandothers whenproblemsarestillsmall

MostCommonStartingPoint
Rentfarmbuildings,land,houseorcombo Buylivestock,minimallineofmachinery Buyfeed Customhire,whennecessary Driveanddetermination>Equity

FactorsThatSuccess
Familycloseby Goodcommunicationskills Frugality Abilitytokeepfeed&vetcostslow Payingdownprincipal asap Curiousmind Goodrecordkeeping Multiplesourcesofcapital

CausesofTrainWrecks
Communicationbreakdowns Vagueoperatingagreements Buyingtoysinsteadofpayingbills Highlivestockillness/deathrates Poorrecordkeeping Poorworkhabitswatchingcartoons insteadofwatchingforheats

Understanding,UsingFinancial Statements
BalancesheetWhatthefarmisworth, howitsfinanced IncomestatementHoweffectivelythe farmgeneratesprofits StatementofcashflowsWhere$$come from,wheretheygo,howmanystick around

FourMeasurestoConsider
Liquidity Solvency Profitability Balancesheet Incomestatement

Repaymentcapacity Statementofcashflows

TheBalanceSheet
Asnapshotoftheinvestmentinthefarmbusiness (assets) andthefinancingmethodsused(acombinationof liabilities and owners equity)atagivenpointintime.
Assets Everythingthatisownedbyorpayabletothebusinessas ofthedatethebalancesheetisprepared Liabilities Allobligationsowedbythebusinessasofthebalance sheetdate Owners Equity or Net Worth Totalassetsminustotalliabilities

InformationFromBalanceSheet
LiquidityAbilityofthebusinesstomeet itscurrent(shortterm)obligationswith currentassets Solvency Abilityofthebusinesstopay offallofitsdebtsifitweretobesold tomorrow

CommonLiquidityProblems
Poorlystructureddebt Payingforlongterm assetsasiftheyarecurrentliabilities Highcurrentliabilitiesforcingsalesofinventoryat unprofitableprices Uncollectable accountsreceivablecontinuingto showupascurrentassetsonbalancesheet

CommonSolvencyProblems
Capitalinvestmentstoohighrelativetopotential income Assetsdepreciatingfasterthantheloanbalancesare beingpaidoff

TheIncomeStatement
Oneyearsincomeandexpenses,andhowmuch revenuewasretainedbythebusiness. Income Includescashsalesoffarmproducts,
governmentpayments,customworkincome.Alsoincludes changesintheinventoryoffeed,crops,andlivestock.

Expenses Includesallcashoperatingexpenses
includinginterest(butnotprincipal)payments.Italso includesdepreciation.

InformationFromIncome Statement
Profitability measures
Net farm income Returnforyourunpaidlabor, management,andfinancialinvestmentinthefarm Rate of return on farm assets Theinterestrate beingearnedonalloftheinvestmentsinthefarm Rate of return on farm equity Theinterestrate beingearnedonyourinvestmentinthefarm Operating profit margin Theoperatingefficiencyof thebusiness

CommonProfitabilityProblems
Feedcoststoohigh Overheadcoststoohigh
Preachingto thechoirhere

StatementofCashFlows
Allcashflowingintotheoperation(includingloan proceeds)andallcashflowingout(includingfamily livingexpenses,taxes,principalandinterest payments. Anythingleftoverisconsideredcapital replacementmargin

CommonCashFlowProblems
Poorlystructureddebt Toomuchdebtrelativetoincome Rarelyisfamilylivingexpensethe problem!

ProfitabilityandCashFlow
Relatedbutverydifferent
Canbeprofitablewithnegativecashflow Canhavestrongcashflowandbeunprofitable

Anumberofwaystoimprovecashflow Threewaystoimproveprofitability

IncreasingProfitability
1. Reduceoverheadcosts(Theyarentreallyfixed) 2. Improvegrossmargin getmoreforyourmilk,cullcows,otherproducts cutvariablecosts 3. Increaseassetturnover (Assetturnoverratio=Valueoffarm production/Averagefarmassets) Increasedproductiononlyimprovesprofitabilityif variable and overheadcostsstaythesame

BusinessPlanningCosts
OverheadCosts
Coststhatexistonthe farmwhetherornot anythingisbeing produced Canincludemortgage, taxes,depreciation, labor

VariableCosts
Coststhatincreaseas farmproduction increases Canincludesseed, feed,fertilizer,vet expenses,utilities

Totalgrossvalueoffarmproduction

fi t ro
Variablecosts Feed,vet, breeding,milkhauling,etc

$
L s s o
OverheadcostsLand,labor, buildings,equipment Breakeven

Numberofcows
Howoverheadandvariablecostsrelatetoprofitondairyfarms

Totalgrossvalueoffarmproduction

Variablecosts

$
s s o

fi t ro
Overheadcosts

OriginalBreakeven NewBreakeven

Numberofcows
Onewaytoincreaseprofitability:Reduceoverheadcosts

Totalgrossvalueoffarmproduction

os blec a Vari

ts

$
L s s o

fi t ro
Overheadcosts OriginalBreakeven

NewBreakeven

Numberofcows
Anotherwaytoincreaseprofitability:Reducevariablecosts

Totalgrossvalueoffarmproduction

fi t ro
V

os l e c b aria

ts

$
L s s o
Overheadcosts Numberofcowsneeded tobreakeven Newproductionlevel

Numberofcows

Athirdwaytoincreaseprofitability:Increaseproduction,keepallcoststhesame

SomeBottomLines
Agoodbusinesswillgenerateincreasinglevelsof profitabilityandcashflowgoingforward
Profitabilitywithoutcashflowisrecipefordisaster Cashflowwithoutprofitabilityisaterminalcondition

Doesntmakesensetoborrowat7%toearn6% Ifabankwontinvestbasedonyourbusiness plan,maybeyoushouldnteither