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Driving Down Costs to Remain Competitive: Part 1

After reaching a record $129 billion in 2013, America’s net farm income is projected by the USDA to fall over the next decade. Nominal net farm income could reach a five-year low of $73.6 billion in 2015, with most of the expected decline attributed to lower crop and livestock prices and receipts.

Fortunately, farm balance sheets are in a strong position going into this economic change. The U.S. farm sector debt-to-asset ratio -- a measure of overall farm financial health -- reached an all-time low of 10.6 percent in 2014 and is projected to increase slightly to 10.9 percent for 2015.

We, like others in the industry, are working with producers to approach today’s environment as an “agriculture efficiency cycle” – a window of opportunity during which producers can position themselves for continued success by finding ways to drive down their cost per unit of production. In this two-part series, we look at topics such as efficiency gains, debt structure, living costs and more. Today, we bring you excerpts from AgriThought, produced by AgriBank, the funding bank for FCSAmerica and other Farm Credit Associations serving 15 states in the heartland. Part two will focus on the conversations our financial officers are having with producers to develop cost-saving strategies.

2014-2015: Net farm income

The USDA projection of a 16.3 percent decline in aggregate nominal net farm income for 2014 is followed by a further decline of 31.8 percent in 2015. While most of the decline in 2014 can be attributed to sharply lower crop receipts (down $20.3 billion) and much higher cash expenses (up $17.6 billion), the culprit in 2015 is much lower cash receipts for both livestock (down $10.1 billion) and crops (down $15.6 billion).

Cash expenses are expected to increase only modestly (up $1.6 billion), while total farm production expenditures are projected to increase $2.2 billion in 2015. Feeder livestock purchases (up $3.5 billion) and labor expenses (up $1.4 billion) are expected to remain major expenses. Counterbalancing some of the increases are projected declines in petroleum, fuel and oil, fertilizer and feed purchases.

Producer capital expenditures are projected to significantly decline in 2015, particularly in the areas of vehicle and machinery purchases (down $1.8 billion, or 6 percent); and buildings and land improvement expenditures, including operator dwellings (down $1.3 billion, or 11.4 percent).

The USDA’s resulting snapshot of projected U.S. farm income in 2015, as compared to the previous four years:Projected U.S. Farm Income in 2015

The answer to lower net farm income? Agriculture efficiency

Managing tighter margins requires bringing income and expenses in line. Historically, this is best done by implementing a higher level of operational efficiency that drives down the cost per unit of production.  Producers can begin by focusing on achieving efficiencies in the largest cost categories for the commodities they produce. In these categories, even a small increase in efficiency can result in a significant reduction in the cost per bushel of production.

Consider corn, the largest crop in terms of total production in the AgriBank District. The accompanying pie chart shows the USDA 2015 forecast for corn cost of production.

USDA 2015 Corn Cost of Production

If you’re a corn producer, you need to answer some tough questions. Are you in a position to negotiate more favorable terms to rent cropland? What is the trade-off on your fields between fertilizer/chemical usage and the choice of seed (genetically modified or not)? Would it be more cost-effective to delay purchases of new equipment when compared to the anticipated maintenance costs for new equipment? Could use of precision farming and Enterprise Resource Planning (ERP) improve your productivity and realize enough cost savings to justify the investment? The answers to these and related questions will be different for each producer, depending on his or her unique circumstances.

The cost of borrowing

In 2012, about 68 percent of the total U.S. farm debt was held by 4 percent of producers. This same small percentage of producers accounted for 48 percent of aggregate net farm income. Opportunities still exist to lock in fixed long-term rates at near historically low levels.

Taking the bull by the horns

Producers are not able to control market forces, such as commodity prices, that affect their financial well-being. But they can control how they respond to these forces. The following is a list of some of the steps you, as a producer, can take to adapt to today’s agriculture efficiency cycle:

  • Understand all of the primary factors that determine your cost per unit of production.
  • Research and thoroughly evaluate those practices, techniques and technologies that have the potential to reduce the major cost of production categories. Adopt those that can have a major impact on your cost per unit of production.
  • Review the debt structure of your balance sheet and how your debt payments align with your cash flow abilities.
  • Take advantage of historically low interest rates by locking in fixed rates when appropriate.
Read the next post on Driving Down Costs to Remain Competitive: Part 2.

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