Categorize your inputs costs so they can be managed effectively

By Doug Rich

Greg Wolf, Ag Consultant, Kennedy and Coe, LLC audio presentation

FAMILY BUSINESSES – Greg Wolf, Kennedy and Coe, discussed family business management issues at all three stops on the Small Grain Solutions 2009 tour.Wolf said family businesses face challenges that corporate America does not experience. (Journal photo by Jennifer M. Latzke.)

We have some particular joys in family businesses and we have some particular challenges in family businesses that corporate America does not deal with,” Greg Wolf said.

Wolf, with the Agriculture Group at Kennedy and Coe, LLC, made a presentation about family business management issues at the Small Grain Solutions seminar sponsored by John Deere and High Plains Journal.

Wolf likes to approach these issues from a portfolio perspective, which is not a term we use very often in agriculture.

“I like to keep bringing my customers back to this central truth,” Wolf said. “Even though we are involved in agriculture, we are capitalists and we have invested capital assets into agricultural production. We have committed them, with the expectation of some return. We must view those investments with a portfolio perspective as if we were in a non-ag investment.”

The more risk producers assume with their capital investments, the higher their expectation of a return. All of their investment decisions relate to this relationship between risk and return.

Agricultural producers face a variety of risks including business climate, financial, integrity and reputation, regulatory risk, strategic positioning, and weather. Wolf said producers need to ask themselves what kind of return to investment is acceptable given the level of risk they incur.

Wolf did a benchmarking study based on financial data from their 20 largest agriculture production clients. These clients represent mostly cropping operations located in Kansas, eastern Colorado and northern Oklahoma. They grow everything from irrigated corn to dryland wheat. Together they farm a little over 13,000 acres each.

Wolf compiled financial data for 2006 and 2007 on these operations and compared their return on equity (ROE) to financial groups. Their ROE was 05.7 percent in 2006 and 19.1 percent in 2007. This compared to 0.65 percent in 2006 and 8.23 percent in 2007 for the Kansas Farm Management Association. The S&P 500 in 2008 had an ROE of 37.0 percent and the Berkshire group had an ROE of 09.6 percent in 2008. The average 5-year certificate of deposit returned 3 percent.

“If over time our return to equity runs under 3 percent, we are not generating enough return relative to all of the risk we are exposed to,” Wolf said.

Although agriculture has its challenges as a whole, it has looked pretty good relative to other financial assets over the last couple of years, Wolf said.

“We need to categorize our costs in a way that we can manage them,” Wolf said. In his crop budget example, Wolf took an indepth look at machinery costs and did a line item breakdown. Wolf looked at custom hire, depreciation, fuel, oil, rents, repairs and supplies. He likes to allocate machinery costs on a per acre basis across the whole farm. The producers in his benchmarking study had machinery costs of $53.91 per acre, which was 22 percent of their revenue.

To manage machinery costs, Wolf suggested thinking about optimum equipment utilization over all the acres you farm. He said the farmers in his study had newer equipment but they had very competitive equipment costs.

There are several strategies for obtaining optimum equipment utilization such as sharing equipment, growing the operation, renting equipment, custom farming and reducing tillage. Wolf said not to overlook new technology. New technology can be cost effective.

“We should analyze each cost center to isolate areas that we can impact with management decisions,” said Wolf. Wolf said producers should ask themselves some key questions.

Although financial planning is vital, Wolf said with family businesses the things that count the most are often things that cannot be counted. They are not financial in nature.

In his benchmarking study, he asked the 20 clients about the greatest satisfactions they experienced in their family business and the greatest challenges. The answer to both questions came back — relationships, relationships, and relationships.

The three primary components or systems in a family business, according to Wolf, are management, ownership, and the family. Wolf has found that, the further away their clients are removed from the founder of the farm, the greater the potential for chaos and confusion.

The roles of management are production, marketing, financing, accounting and taxation. Its goal is operating profitability. This is measured by return on assets.

The roles involved with ownership are shareholder, director, investor and heir. Ownership’s goal is portfolio stewardship and it can be measured by return on equity.

The roles in the family component are child, sibling, parent, grandparent and friend. The goal is relationship harmony. As more players are involved in the farm, there can be role confusion. Wolf said the measurement is return on relationships.

To determine the quality of these relationships, producers should ask themselves if they are happy, if their family is happy and if their employees are happy.

“The relationships that we have in family businesses require investment and they have significant risks,” Wolf said.