Does Size Matter? – for Sep. 6, 2010

It is a common question that seems to consistently rear up in our discussion with farm managers: What is the optimal size for a farm operation? You have probably heard that it isn’t the size of the vessel but the motion of the ocean that matters and farming is no exception. We have found that there is a far better correlation to profitability and efficiency with well-managed farms than simply with a given farm’s acreage base.

A well-managed farm is one that not only has a productive capacity that is not beyond the skill set of the management team, but more importantly, it is also a farm that is leveraged correctly. In other words, the farm maintains a responsible equity and debt relationship, and expansion decisions are accountable to the impact they will have on that relationship. All too often we come across farms that are focused solely on growth, expecting to achieve economies of scale when in fact, they have stretched their equity too thin across too many productive units and as such, the business cannot operate sustainably. As a result, any blip in production or prices leads to cash-making management decisions and lost efficiency. Often liquidation of assets or a restructure is necessary in order for the business to continue in this scenario.

The agribusiness industry isn’t innocent here. Industry wants to sell more product or services regardless of the number of farmers it sells to, and, as such, the environment at shows such as Big Iron, Farm Progress, or Ag Days, often leaves a farmer feeling that he needs to grow fast and furious in order to be relevant. The fact remains that a moderately sized farm that is leveraged properly and operates within the management team’s skill set can have a larger net income than an operation twice its size.

As an example, let’s compare two cereal and oilseed farms, each with $3 million worth of equity. Farm A elects to operate 3,000 acres with only $750,000 of debt and Farm B operates 6,500 ac. with $3 million of debt. Essentially, Farm A is choosing to operate at 80 per cent equity and Farm B is choosing to operate at 50 per cent equity. We have seen both farms operate successfully and put together a list of management attributes the owners possessed that made them successful (see Figure 1).

Generally speaking, the most financially successful farms are more similar to Farm A. Given the volatility in production and price, a higher equity ratio becomes a powerful risk management strategy for the farm business. It’s not uncommon for Farm A to achieve a higher net income than Farm B even given the additional acres.

We do work with some farms that have the risk tolerance to operate as a Farm B operation. These operations, while exciting to work with, experience wild fluctuations in both net incomes and productive capacity. Very few farm managers with this risk tolerance have the skill set necessary to manage the risk in this set of circumstances.

The point of this article is to understand your risk tolerance and management skill set first. Through understanding these you then need to match the leverage and equity positions of the farm with this risk tolerance and skill set of management. Be objective and realistic in analyzing your skill set and goals. Size definitely does matter but not in the traditional sense. There is no optimal size of farm for profitability only optimal size of farm for the management team.

AndrewDeRuyckandMarkSloanemanage twofarmingoperationsinsouthern ManitobaandarepartnersinRightChoice ManagementConsulting.Withover25years ofcumulativeexperience,theyoffersupport infarmmanagement,financialmanagement, strategicplanningandmediationservices. Theycanbereachedat [email protected] and [email protected] or204-825- 7392and204-825-8443

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FIGURE 1. FARM A 1) OWNER ENJOYS A VERY HANDS-ON APPROACH TO OPERATIONS 2) IF PRODUCTION OR PRICE PROBLEMS ARISE, WORKING CAPITAL WILL ABSORB 3) LOWER RISK TOLERANCE. NOT WILLING TO RISK IT ALL 4) MANAGEMENT MAKES ALL INPUT AND COMMODITY MARKETING DECISIONS WITH MINIMAL CASH FLOW INFLUENCE FARM B 1) HIGH RISK TOLERANCE 2) HIGH DEGREE OF CASH FLOW MANAGEMENT 3) IF PRODUCTION OR PRICE PROBLEMS ARISE, LIQUIDATION OF ASSETS IS NECESSARY 4) VERY EFFECTIVE HUMAN RESOURCE MANAGEMENT, INCLUDING LOGISTICS MANAGEMENT 5) HIGH DEGREE OF RISK MANAGEMENT (UNDERSTANDING COST OF PRODUCTION, MARKETING, SOURCING INPUTS) 6) CLEAR COMMUNICATION AND HEALTHY CREDITOR RELATIONSHIPS

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The fact remains that a moderately sized farm that is leveraged properly and operates within the management team’s skill set can have a larger net income than an operation twice its size.

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