Managing With Tight Operating Margins Ron Haugen North Dakota State University Extension Service 2016 Extension Risk Management Educational National Conference Fort Worth, Texas April, 2016

Profit vs Cash Flow Recognize the difference between net income and net cash income Do not have to make a profit every year Must meet cash obligations every year 2

Profitability or Net Profit An accounting of the value of all resources used to produce a product Some costs are non-cash depreciation unpaid owner/operator and family labor Inventory adjustments (whole farm) 3

Cash Flow Cash sales must be adequate to pay all cash expenses Any shortfall must be made up by borrowing 4

What is the Typical Response to Tighter Operating Margins (lower prices)? 5

Reduce Expenses Which expenses? How will they be reduced? 6

This strategy would work much better if it could be retroactive We have principal and interest payments today due to purchases in previous years that were financed 7

Remember the Nemesis of the Mid 1980’s “Leverage” The ability to use a small amount of your money, added to a larger amount of the bank’s money to purchase assets 8

North Dakota Crop Budget Regions 9

NW NC SW NE SC EC SE NV SV $71.00 $ $ $52.50 $94.00 $96.00 $39.50 $66.80 $70.00 $30.00 $57.10 $62.50 $27.50 $37.70 $38.00 $55.50 $92.70 $90.00 $38.00 $55.50 $56.50 $36.50 $50.20 $50.00 $28.00 $36.80 $35.00 North Dakota Land Rents by Region 2008, 2013 and 2016 Source: North Dakota Ag Statistics Office of USDA 10

Projected North Central Budgets, 2013 Spring WheatCornCanolaSoybeans Per Acre Market Yield Market Price Market Income$ $ $362.60$ DIRECT COSTS Seed Herbicides Fungicides Insecticides0.00 Fertilizer Crop Insurance Fuel & Lubrication Repairs Drying Miscellaneous Operating Interest Sum of Listed Direct Costs$ $ $201.19$ INDIRECT COSTS Misc Overhead Machinery Depreciation Machinery Investment Land Charge50.20 Sum of Listed Indirect Costs$88.58$106.40$89.92$85.29 Sum of all Listed Costs$255.96$374.83$291.12$ RETURN TO LABOR & MANAGEMENT$65.20$126.47$71.48$ TOTAL COSTS PER UNIT$6.92$4.16$0.20$8.30 Percent of Rotation40.00%10.00%30.00%20.00% WEIGHTED RETURN TO LABOR & MANAGEMENT$

Projected North Central Budgets, 2016, Difference from 2013 Spring WheatCornCanolaSoybeans Per AcreDifferencePer AcreDifferencePer AcreDifferencePer AcreDifference Market Yield Market Price5.26 (3.42)3.50(2.07) (0.10) 7.85 (4.50) Market Income$ (89.72)$360.50(140.80) $ (113.96) $ (102.45) DIRECT COSTS Seed15.73 (4.07) Herbicides Fungicides Insecticides0.00 Fertilizer56.66 (4.43)70.77(9.79) (11.03) 7.62 (0.52) Crop Insurance11.30 (5.40)16.70(14.60) (1.60) (5.00) Fuel & Lubrication10.41 (7.27)14.75(11.07) (8.02) 8.26 (6.35) Repairs Drying Miscellaneous (2.50) Operating Interest3.19 (0.57)5.26(0.78) 3.90 (0.62) 2.85 (0.45) Sum of Listed Direct Costs$ (14.15)$252.72(15.71) $ (13.68) $ (10.16) INDIRECT COSTS Misc Overhead Machinery Depreciation Machinery Investment Land Charge50.00 (0.20) (0.20) (0.20) (0.20) Sum of Listed Indirect Costs$ $ $ $ Sum of all Listed Costs$ (10.45) $ (11.72) $ (11.95) $ (7.85) RETURN TO LABOR & MANAGEMENT$(14.07) (79.27) $(2.61) (129.08) $(30.53) (102.01) $18.94 (94.60) TOTAL COSTS PER UNIT$5.58 (1.34) $3.53 (0.63) $0.17 (0.03) $7.24 (1.06) Percent of Rotation40.00%10.00%30.00%20.00% WEIGHTED RETURN TO LABOR & MANAGEMENT$(11.26) 12

What Factor has the Greatest Impact on Net Return Per Acre? 1.Yield 2.Price 3.Costs 13

Farm Groups Average Yield Percent of Average Average Price Percent of Average All Farms %$ % Low 20 % %$5.6793% High 20 % %$ % Wheat on Cash Rented Land, , Red River Valley Farms Sorted by Net Return per Acre source: FBM Reports, Red River Valley 14

Farm Groups Average Direct Cost Percent of Average Average Land Rent Percent of Average All Farms$ %$ % Low 20 %$ %$ % High 20 %$ %$ % Wheat on Cash Rented Land, , Red River Valley Farms Sorted by Net Return per Acre source: FBM Reports, Red River Valley 15

All FarmsLow 20%High 20% Gross Income$352.64$267.85$ Direct Costs$190.75$197.94$ Land Rent$ 84.59$ 94.18$ ROVC$ 77.30$ $ Wheat on Cash Rented Land source: FBM Reports, Red River Valley 16

All FarmsLow 20%High 20% Gross Income$352.64$288.16$ ROVC$ 77.30$ -3.96$ What if All Farms Sold For the Average Price ($6.10) 17

All FarmsLow 20%High 20% Gross Income$352.64$288.16$ ROVC$ 77.30$ 12.82$ If All Farms Had Average Price, Direct Cost and Land Rent 18

How Does This Help Us in Dealing with Leaner Operating Margins? Protect yield – yield is the most important factor in net returns per acre Can you cut costs without cutting yield? 19

Three Ways to Cut Costs Reduce the quantity of inputs Change the inputs Lower price for inputs 20

Where Do You Reduce Expenses SeedOverhead HerbicideMachinery Principal FungicideMachinery Interest InsecticideLand Cost Fertilizer Crop InsuranceLabor & Mgmt (operator) Fuel & Lube(family living) Repairs Drying 21

Should You Drop Rented Land? If gross return is greater than direct costs plus land rent, keep it, because it is contributing to ROVC 22

Fixed Cash Rent Methods 1.Cash rent market approach 2.Landowner’s cost or desired return 3.Landowner’s adjusted net-share rent 4.Operator’s net return to land 5.Percent of land value 6.Percent of gross revenue 7.Dollars per bushel of production 8.Fixed bushel rent 23

Putting Flexibility in Cash Rent Agreements Crop-share leases were the original flexible rents –The scale of today’s operations makes share rents somewhat impractical Cash rents may be adjusted by market prices, crop yields and production costs 24

Advantages of Flexible Cash Rents 1.Landowner shares in additional income from: Price increase Yield increase 2.Reduced risk for operator when: Prices drop Yields are reduced 25

Disadvantages of Flexible Cash Rents 1.Increased risk for landowner 2.Landowner may be concerned about accuracy of reported yields 3.Higher rent due to increased yields means the operator may be giving up some of the benefit from managerial input 4.Calculating the rent requires more management and communication 26

27 Managing With Tight Operating Margins Meetings Banks Producer Meetings Ag Lenders Agent Training North Dakota & Minnesota MN

Number of Meetings and Attendees 22 meetings at 20 locations 1215 attendees 28

Make-up of Meeting Attendees Farm operators Land owners (landlords) Lenders Farm managers 29

Take Away Points Yield is most significant determining factor for profitability What costs can be cut without cutting yield? 30

31 Acknowledgments: Dwight Aakre, North Dakota State University Extension Service, Farm Management Specialist

Thank You! Any Questions? 32 Contact Information: Ron Haugen Dwight Aakre