As we bring in the New Year, I would guess that many of us are glad to see the calendar turn from 2020 to 2021. Whether its COVID related challenges, political division and unrest, global competition or commodity price volatility - all of these outside forces can cause considerable stress for the agricultural producers we work with.
During these times of high stress, I generally try to have my ag customers focus on what they can control. When it comes to getting the highest return on investment, I like to start by reviewing the producer’s Operating Expense Ratio (“OER”) – operating expenses divided by gross revenue. In basic terms, this ratio tells the producer what percentage of their gross revenue is tied up in the expenses it takes to generate that revenue. Another way to put it is “for every dollar of revenue generated, it costs x number of cents to produce it”.
When reviewing the variables that make up the OER, I start with looking at the agricultural producer’s expense line items, since the producer generally has more control over expenses than revenue (especially when looking at the volatility of prices received for agricultural commodities produced).
For a dairy producer, I first concentrate on feed expense because this is typically the highest expense line item on the income statement. For a crop producer, I start with reviewing crop input expenses with the producer. I then proceed to ask numerous questions related to the expense such as: “Have you periodically reviewed your feed ration with your nutritionist to see if the ration is providing the highest level of production and quality at the most economical cost?”; “How can you improve your forage quality and yields in order to reduce the amount of higher cost supplements in the ration?”; “Have you reviewed your crop plan with your agronomist to see what costs savings can be implemented without sacrificing quality and yield?”. It is through this dialogue that the producer really starts to concentrate on areas that he/she has control over. This dialogue then leads to discussion on other expense line items and cost saving ideas that do not have a negative impact on production and quality. Another point of discussion I bring up is crop insurance. Is the producer insuring his/her considerable investment in the crops he/she is growing?
On the revenue side of the OER, direct producer control is more limited, especially on the price received for the commodity produced. However, the correlation between the amount and quality of the commodity produced and how cost effective the producer is in producing that commodity is a valuable area of discussion. When looking at the price, I generally ask the producer what marketing tools he/she has used to protect his/her cost of production? This leads to discussion on the producer’s cost of production and what specific marketing tools are being utilized for price protection (i.e. – USDA programs such as Dairy Margin Coverage and Dairy Revenue Protection, forward contracts and/or options).
Breaking down the variables that make up the OER allows the producer to concentrate on the variables he/she has control over. This, in turn, allows the producer to concentrate on becoming more efficient in the production of the agricultural commodity he/she produces. In an industry with high price volatility and tight margins, efficiency is a key to success.
So, with the New Year upon us, a useful resolution to consider is to focus on the things you can control and take a little time to R-E-L-A-X.
Jeff Wilke is vice president, agribusiness lender with Denmark State Bank and currently serves on the WBA Agricultural Bankers Section Board.