Farm C 

Farm C has decent performance on operations: cost of goods sold is only 1% off the benchmark and direct operating expenses are better than Farm A’s. $675,000 of operating income is 45% of revenue, putting it just below the benchmark.

The issue with Farm C is that is has a very high cost of capital and relatively high interest expense, implying a significant amount of debt. While the farm is generating a healthy amount of cash to pay for its large capital stock, capital cost is limiting profitability.

It’s possible Farm C has very recently purchased assets aimed at growth, but the effect of those assets has not shown up in revenue yet. If this is not the case, Farm C needs to ask whether assets can be used to generate more revenue, or whether they should be sold off.

Comparing Farms A, B, and C demonstrates the importance of understanding the context of financial activities. There are layers of questions that need to be addressed to diagnose performance. Measuring an individual farm’s performance compared to the benchmarks identifies strengths and weaknesses, further enabling strategic decisions.

Farm B 

Farm B clearly indicates issues in performance: cost of goods sold and direct operating expenses are higher than their benchmarks. Together, these limit operating income to less than half the benchmark, at $352,000. Cost of capital and interest expense are in relatively good shape, but the operating issues bring the farm’s net down to less than $100,000 on $1.5 million of sales. 

Does a weather or disease issue makes this year an outlier for Farm B?  If the year is consistent with the trend, the farm has issues with production and/or marketing—with little opportunity for growth due to low profitability. Yields may be too low for the amount of inputs being used. Moreover, labour and/or machine-operating costs are too low.

Fundamentally, this farm needs to focus on these areas to improve performance.

Farm A 

Farm A has excellent performance on cost of goods sold, spending only 25.5% on production inputs such as fertilizer, seed, and crop protection material compared to the benchmark of 30%.

It’s pivotal to understand the context of a farm’s performance. Farm A needs to assess whether this year’s performance is in line with its trend over time. If there’s a significant change in either direction—ask why. If performance is consistent, focus should be put on individual parts.

Direct operating expenses are not as good at 23.5%, versus the benchmark of 17.5%. Labour costs and/or machinery operations are higher than the benchmark. Farm A needs to focus on direct operating expenses to determine where the problem lies. Is it labour, machinery operations, or transportation that is out of line? Can it be fixed—and, if so, how?

Farm A also has lower capital cost, but higher interest expense. Taken together, this might suggest that the farm’s investment in machinery and equipment is low, making labour and machine-operating costs high (especially if repairs and maintenance are high). With the level profitability, it may be time to invest in more capital in order to reduce both labour and operating costs. The relatively high interest cost may indicate this is already under way.

Strategically, Farm A needs to focus on the direct operating expenses, with plenty of opportunity to grow.