It is often perceived separate from the routine management of the farm and may be required or used by lenders. But financial management is not only a colorful thread of the operation. It reveals the very fabric of a farm’s decision-making. The purpose of farm financial management is to effectively evaluate and make decisions based on sound analyses, which are enhanced with benchmarking principles.
The basic concept of farm financial management follows a continuum, beginning with farm financial records – including tax preparation – through the construction of financial statements and all the way to decision-making. The intention behind the financial-management model is to make sound financial decisions for the farm.
Benchmarking is the practice of comparing your farm’s financial performance to: 1) your own past performance or future goals, 2) other farms’ performances, or 3) established guidelines for performance. Although the power of financial benchmarking is recognized, it continues to be used by only a minority of farms. Farmers will usually admit the importance of good record-keeping but usually rank it fourth behind field work, buying and selling machinery and crops, and working on farm machinery.
Accurate records necessary
Financial benchmarking requires accurate and consistent financial records that are organized into financial statements (balance sheet, income statement). From these documents, financial measures can be calculated, which provide the metrics used in benchmarking.
The Farm Financial Standards Council (FFSC) recommends standards for financial statements and measures. There are 21 measures across five criteria to determine a farm’s financial performance. The five criteria are: liquidity, solvency, profitability, repayment capacity and financial efficiency.
A farm may use all 21 measures, or select measures to benchmark within or across the five criteria. Some measures are absolute values, while others represent ratios. Absolute values, like net farm income, may be insightful for benchmarking past performance or future goals. However, absolute values are subject to scale effects and may not be useful to compare a 100-cow dairy to a 500-cow dairy. A ratio such as the rate of return on equity may be more insightful in making such a comparison.
Furthermore, the equity-to-asset ratio versus the debt-to-asset ratio – while providing similar insight to solvency – may be preferred by the farmer because it reflects his or her claim upon the assets versus lenders’ claims. Therefore, choices exist as to which criteria to benchmark and which measures to use among the criteria.
As mentioned, there are three focuses for benchmarking a financial performance: internal, external and accepted standards. Financial scorecards are available for benchmarking, which offer guidelines as to performance. Metrics may suggest that values such as return on assets (ROA) or return on equity (ROE) are vulnerable, acceptable or strong for a farm, as shown in Table 1.
Financial benchmarking compares measures of financial performance, which in turn, provide insight to the strengths and weaknesses of a farm. Benchmarking compares a farm’s financial performance to: 1) its own past performance or future goals, 2) other farms’ performance, or 3) guidelines for performance. Using your current financial statement(s), calculate a couple ratios and compare them to the financial score card.
If you have more than one year’s set of financial statements, pick three to five ratios off the scorecard, compare them and see how they have changed over the years. Note, however, that financial scorecards will vary based on enterprises, the purpose they serve, when they were developed and for other reasons. This should be considered when using a financial scorecard for benchmarking.
There are various farm management associations and universities which have financial benchmarking data: Wisconsin (Farmbench), Minnesota (FINBIN) and New York (DFBS) are just a few. It is important to choose one that provides training, financial analysis (calculating your benchmarks) and comparison reports and/or consultations.
References omitted but are available upon request. Click here to email an editor.
A benchmarking scorecard is available at: Farm Finance Scorecard.
- Associate Director
- Center for Dairy Profitability
- Email Jenny Vanderlin