Transferring Your Farm Business to the Next Generation

Bulletin 862

Guidelines for Measuring Financial Viability

There are few indisputable "rules" for predicting the financial success of a farm business. However, there are some guidelines that can be used to evaluate the chances of success. When transfers are considered, these guidelines may be useful to all persons involved in the planning. Future problems may be avoided or minimized. These measures should be used before, during, and after a transfer.

A farm business must be profitable in the long run in order to continue existence. The key internal factors that affect profitability in any farm business are:

1. Size
2. Rates of Production
3. Labor Efficiency
4. Capital Efficiency
5. Cost Control
6. Marketing and Purchasing

To perform the management functions of planning, organizing, staffing, directing, and controlling effectively, the manager must have a mission, objectives, and goals that relate to these factors. Each manager should set his or her own goals based on past results, current conditions, and long-range objectives. Frequently, managers need a benchmark from which to begin.

Enterprise Size Guidelines

The guidelines can be either input or output measures. Most economies of size can be reached utilizing no more than two full-time workers. Therefore, getting up to at least a two-person operation may be the goal for least-cost production and efficiency. With typical technology, the following enterprise sizes should provide full employment for two people where the farm produces most of the grain and roughage if there is livestock:

It is important to recognize that minimum or near minimum cost of production per unit may be possible at these sizes, however, the resulting net income may not be satisfactory.

Rates of Production

Production efficiency is critical due to its effect on profitability. Following, are some enterprise guidelines that should be met or exceeded over time:

Livestock

Dairy

Feed costs for total herd of less than $6.50 per cwt of milk produced.
Feed costs of less than $1.00 per day for replacements and dry cows.

Beef Cow/Calf

Ewe/Lamb

1.50 lambs sold per ewe per year
Market lambs gain 0.4 lb./day
Under 4.25 lb of concentrate per lb of gain

Farrow/Finish Swine

18 pigs marketed per female per year
Under 360 lbs/feed per 100 lbs. of pork produced (whole herd)
Market hogs gain over 1.8 lb per head per day
$35 or less cost/cwt. pork produced
9.7 pigs weaned per litter
85% of carcasses in premium weight and quality category

Finishing Cattle

Less than 7 lbs. of feed/lb. of gain
Market animals gain over 2.5-3.0 lbs. per head per day
Market weight-1000-1300 lbs
Carcass weight-650-800 lbs
More than 75% of carcasess >= low choice grade and 2-3.5 Yield Grade

Crop Yields

Following, are average crop yields for Ohio for two five-year periods. Yield goals need to be related to soil productivity and fertility levels. Producers should be measuring average yields over several years as well as knowing their trend in yields.

Labor Efficiency

Labor is one of the major resources used in agricultural production in addition to land, capital, and management. The amount and quality of land, extent of mechanization, and management will affect labor productivity. The following guidelines are desirable minimum levels of labor productivity for output and typical labor input. Use the input measures to estimate the size of the operation needed to require 2,500-3,000 hours of labor per full-time worker.

Capital Efficiency

Modern farms are capital-intensive, therefore, any capital invested should be used efficiently. Asset turnover measures capital efficiency in terms of output (value of farm production per year divided by average value of total farm investment). Some measurements use Gross Revenues rather than Value of Farm Production. Minimum suggested turnover ratios are:

Desirable turnover ratios will vary with change in tenure (pct. of land owned) and capital invested in machinery and facilities.

Capital efficiency can also be measured in terms of financial investment per unit and/or debt load per unit. The following are conservative guidelines for these measures:

Cost Control

Economic theory states that in the long run, the average cost of production will equal the average price. Therefore, to be profitable over time, a producer must have lower than average costs. Producers should compare their total costs of production (variable plus fixed costs) with the following prices. These figures are the average prices received by Ohio farmers in recent years:

Expenses as a percent of value of farm production should also be controlled. Since profits are a function of (prices - total cost of production per unit) x no. of units produced, both prices and costs require management attention.

Marketing/Purchasing

Marketing decisions are critical to profitability due to the variability of prices monthly, annually, and cyclically. Producers should strive to price their production in the upper half of the annual price variations but only produce if the expected price is greater than variable costs (in the short run). Comparing your average prices received with these can provide some measure of marketing effectiveness.

Compare your costs with prices of these selected inputs. Timely and careful purchasing also can have a significant effect on reducing costs.