The Samuel Roberts Noble Foundation, Inc.   Farm Size Depends on Economic Factors
 

Economics: May 2002

by Paul Joerger

Farm size varies tremendously throughout Oklahoma and Texas, and producers who want to earn their entire living from farming or ranching should calculate the volume of sales needed to meet their financial goals and fully employ their labor and management resources. Producers should consider the amount of funds for family living, returns to equity capital, and income tax liabilities when making their calculations.

For example:
Family living expenses - $30,000
Expected return to equity capital - $15,000 (5% * $300,000)
Estimated income tax - $15,000
Net farm income (NFI) - 20% of gross farm returns (GFR)
In this case, the GFR must be $300,000 in order to meet the operation's established financial goals.
($30,000 + $15,000 + $15,000)/.20 = $300,000

But if the NFI percentage is increased to 25 percent, then the GFR must be $240,000 in order to meet the financial goals.
($30,000 + $15,000 + $15,000)/.25 = $240,000

A highly profitable farm or ranch could achieve a 30 percent NFI with only $200,000 in GFR. Farm size should be dependent upon the profitability of a farm business.

So how is profitability determined? Profitability is probably the most misunderstood term in business. We should always ask the person stating a profitability figure to explain how the value is calculated. Whole farm profitability is determined correctly by subtracting cash farm expenses from gross farm cash revenues while incorporating accrual adjustments for inventory, accounts receivable, farm products produced for personal consumption, accounts payable, prepaid expenses, and accrued expenses. Economic depreciation is also an expense when calculating NFI. Your tax preparer can't inform you of your NFI because they do not have all the information required to make the accrual adjustments. Determining your NFI helps you determine your effectiveness as a manager in creating a return on investment (ROI) for assets committed to the farm business.

For example: if NFI is $60,000, interest paid is $10,000, and unpaid labor and management is $30,000, then the return on investment would be $40,000 (60,000 + $10,000 - $30,000) divided by $500,000 ((asset total at beginning of year $475,000 + asset total at the end of the year $525,000)/2), or an ROI of 8 percent. Profitability or NFI is an important value needed to determine ROI.

Producers seeking methods to improve NFI should consider the following:
  • Examine all production efficiency factors (morbidity, mortality, weaning percentage, pregnancy percentage, average daily gain, death loss, etc.) and strive to be in the top 10 percent of producers in each category.
  • Utilize custom hire versus machinery ownership (baling hay, tractor usage, hauling cattle, etc.).
  • Adopt a recordkeeping system for finances, production, labor, tax, enterprise accounting, etc., to better evaluate opportunities for reducing expenses or further utilizing existing resources.
  • Continue to evaluate technology to enhance revenue or reduce expenses.
  • Seek bids on inputs used on the farm. Feed, fertilizer, seed, animal health, chemicals and other items lend themselves to the bid process. Normally, purchased feed is at the seasonal low in the fall.
  • Lease additional farm or ranch land.
  • Negotiate a more competitive interest rate on outstanding debt. Visit lending agencies and provide them with the required paperwork so they can bid for your credit business.
  • Consider adjusting your marketing plan to incorporate the futures market into your plans. Cow/calf producers may want to change their breeding season to avoid selling calves during times of low market prices, which are primarily in the mid-to-late fall
  • Seek marketing systems that assist in gaining market access. Closed cooperatives are worthy of review, especially those that are vertically integrated/coordinated systems.

These are just a few ideas to consider when attempting to enhance farm profitability.

The size of a farm or ranch should be dependent upon the financial goals of the producer. Meeting financial goals can be accomplished with a lower GFR when the NFI percentage is high.

Increasing NFI percentage requires a high level of willingness on the part of the manager to improve his or her farm management skills.
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