Here we are, once again approaching year end. It goes without saying that 2018 has thrown a few curve balls ranging from less than ideal weather, political/economic challenges pertaining to the whole tariff discussion, and likely some challenges on an individual operation basis. No doubt, a lot of things play into the profitability of a farm operation. As you finish up your year, look back and consider how you are evaluating your profitability.
What Does It Actually Mean to Be Profitable?
By Lee Potts | Vice President / Loan Officer at Security Bank
Farming and ranching are businesses that are always changing. We know that, and you know that. One thing that has not changed, however, is that you have had many people telling you that you need to stay profitable, helping you be profitable, and the list goes on. You already know that you need to be profitable, and as we all know, there have been years that making a profit in the operation has been relatively easy, and there have been years where the task of turning a profit has felt insurmountable.
This formula applies especially if I’m selling widgets retail after I buy them wholesale. To create a formula illustrating the intricacies of the farm profitability formula might take up more room and therefore time you have to read this article as much as time for me to write it. Also, you and I both know what all those moving parts entail already anyway. Depending on whom you talk to, however, profitability could be looked at in different ways.
What actually defines profitability in a farm or ranch operation?
There might be several places to look to determine profitability, but the trick is to pick the right way to look at it. The formula presented above is simple, and one might think that simple is the way to look at it no matter what. While that is correct, sometimes there are tools that you use from day to day that may indicate profitability, but sometimes those tools serve a certain purpose and can be misinterpreted.
How about our old friend, the IRS Schedule F?
It has space to enter income. It has space for expenses and interest, and the bottom line shows a profit or loss. That sounds a lot like the formula presented above. While the Schedule F serves a very important purpose, which helps manage a farmer’s tax liability in various ways, should this form be used to measure profitability? Security Bank collects tax returns from our customers each year, and we do use the income and expense information. That said, we do not view the Schedule F as the final say in profitability. In fact, we don’t consider it to be a tool to determine profitability at all. The data is used as part of some other parts of the credit analysis that we won’t go into in this article, but as mentioned, it is not considered the true measure of profitability. The reason for this is that while it generally conforms to the basic formula of profitability, it also contains figures that are difficult to distinguish in and of itself such as prepaid expenses, deferred income, etc, that may not pertain to the given year.
Maybe Quickbooks (or other accounting software) reports?
While these are also a valuable tool for gauging many things in the business and of course good records come from these to be able to fill out your Schedule F, here again there can be figures contained in these that could skew the profit measure if seeking a true profit figure.
Believe it or not, the balance sheet that you put together with Security Bank, or whichever bank you happen to do business with, can contain the answer to the question of determining true profitability summed up as one number. Yes, it is a listing of assets and liabilities. But going through a certain process can be very eye-opening, be that good or bad. Dr. David Kohl always says to make sure your numbers are put to work for you, and to let the number do the talking. In this, another year of uncertainty and challenges, and the same appearing to be true for 2019, you might be surprised what you find by simply going over your balance sheet as we do every year. As we have asked before, when would you like to find out?