Uncovering the Drivers of Profitability on your Farm By Steve Kluemper Vice President of Credit, GreenStone Farm Credit Services
AS WE CONTINUE ANOTHER HARVEST WITH LOW COMMODITY PRICES, MOST PRODUCERS ARE WONDERING WHERE TO LOOK NEXT TO MAXIMIZE THEIR PROFITABILITY. IN MOST CASES, THE LOWHANGING FRUIT OF EXPENSE CUTTING HAS BEEN DONE. FINDING THOSE AREAS WHERE ADDITIONAL GAINS CAN BE REALIZED REQUIRES MORE INSIGHT AND EVALUATION OF YOUR BUSINESS.
Using financial metrics to analyze the performance of your assets can help you determine where you can maximize profitability and minimize the amount of ineffective assets. The two commonly used metrics to determine the profitability of your assets are the Asset Turnover Ratio and the Operating Profit Margin Ratio. Understanding how these two metrics effect the profitability of your operation can help you uncover areas to minimize losses or increase gains. While computing these ratios on your entire operation can help you see the overall results of the metrics, to do a more thorough analysis, each segment of the business (crops, livestock, replacement animals, etc.) should be reviewed for its own impact on the entire operation. The Asset Turnover Ratio shows how efficiently you are using your assets to generate revenues and is calculated by dividing annual gross revenues by total assets to show revenues as a percent of assets. Producers should 15
Winter 2019 — Partners
target an Asset Turnover Ratio of at least 20 - 40 percent. A high turnover ratio percentage indicates you are getting more revenue out of your assets. Conversely, a lower turnover ratio percentage indicates the assets need to be more productive or they need to be downsized so that the capital investment in the asset can be redeployed to other areas with better turnover. The Operating Profit Margin Ratio indicates what revenues make it to the bottom line and is calculated by dividing your net income after operating and depreciation expenses and owner withdrawals but before interest and income tax expenses by annual gross revenues. This is expressed to show your operating profit margin as a percentage of revenues. Producers should target an Operating Profit Margin Ratio of at least 10 – 20 percent. This ratio can help you see the effect that minimizing expenses has on the overall profitability of the operation.