3. Understand the three levels for good farm business management
When managing your business, it is helpful to plan and monitor these three aspects of your farming business (Section 3 of ‘Farming the Business’):
a. Liquidity – This is the cash flow of the business. A monthly planned and monitored cash flow budget greatly improves the business cash performance. If you are considering off-farm investment, also consider the cash flow implications to your whole business if you were to take cash out for an off-farm investment.
b. Efficiency – One of the key measures of financial performance is how well you have used the resources in your business, as measured by:
- Return on assets managed – This is the measure of how efficiently the total business assets are being managed. Total business assets include the value of owned, leased and share farmed land, machinery, water rights and livestock. When you are considering whether to expand your farm business, this measure assesses if it is a good use of your money. If your business doesn’t improve in efficiency even with further investment, then you should perhaps put your money elsewhere. Knowing your efficiency is a key analytic to help you decide where your surplus money should be going.
- Return on Equity – This is the return you are getting from the assets you own, otherwise known as your equity. This is another key measure when deciding whether to invest off-farm. If your business is generating a 4% return on equity whereas a risk-free bank deposit would return 1%, then you would get better returns investing in your business. Do you know your business’ return on equity?
If you wish to know more about these measures, refer to Section 5.5 of ‘Farming the Business’.
c. Wealth – This is measured by the business balance sheet and is known as Net Worth. Net Worth is the difference between the Total Assets owned and the Total Liability owed. This is the key performance indicator we wish to see grow over time. Further discussion of Net Worth is given in Section 5.3 of ‘Farming the Business’. Any investment consideration, whether to expand your farm business or invest off-farm, should be assessed for its likely impact on the Net Worth.
Farmers often ask ‘Why do I need to know my balance sheet, as I’m not going to sell the farm?’ It’s not just about selling the farm – knowing your Net Worth is part of a risk management strategy as the higher the wealth in your business, generally the better risk is being managed. Also, banks place significant value in knowing your business balance sheet and the equity.