Profitability is in the eye of the beholder. Raising beef may be about many things, and for some, profit is not chief among them. Be honest with yourself. Is the beef operation contributing to your family’s finances? How much do you want your family income to subsidize the beef operation? Turning a profit in a beef business is difficult, but you will not be able to know where you stand until you measure it.
As the cold winter wind blows across the pasture, a great way to stay cozy and warm is to stay indoors, sorting through the farm receipts and expenses over multiple cups of hot coffee. Categorizing these is the first step in filing your Schedule F. Many cow-calf operators file a Profit or Loss from Farming (Schedule F) for income tax reporting. For many, the bottom line of the Schedule F represents their beef operation’s profit (or lack thereof) for the year.
The Income Statement however, not the Schedule F, is the accounting statement that best measures profitability or performance of the farm business. The Income Statement is drafted with figures from the Schedule F, the Record of Business Property Sold (IRS Form 4797) and the current beginning and ending year Balance Sheets. Net Farm Income (NFI) is then calculated from the Income Statement, presenting the beef operation’s profitability.
Profitability is the difference between the value of the goods produced by the farm business and the associated costs for producing them. The Farm Financial Standards Council (FFSC) measures profitability by evaluating the Net Farm Income (NFI) and several ratios and benchmarks them to the farming industry. The ratios include Rate of Return on Farm Assets (ROA), Rate of Return on Farm Equity (ROE) and the Operating Profit Margin (OPM) Ratio. Figures used in these ratios are found on the Balance Sheet and Income Statement.
A farm is more profitable when its ROA is more positive. A negative ROA means the farm is unprofitable. Should the ROA be lower than the interest rate paid on debt, then the farm would be losing money on every dollar borrowed. In the end, this would seriously limit the capacity of the farm to build equity to support its growth. A more positive ROA is a sign of good financial performance.
We want ROE to be more positive, indicating that the owner’s equity is growing. Growth in equity represents growth in your retirement funds and a greater capacity to finance farm expansion. If ROE is low, you may have to ask whether your beef operation, as it stands, can support your retirement and/or expansion plans. Can you make appropriate changes to increase your ROE or would you be better off investing that equity in something other than the farm?
Efficient and profitable beef farms have a larger OPM. Lower OPM Ratios indicate a weakness and/or higher input costs. OPM can be lower on farms where most assets (e.g. land) are rented. A low OPM is usually due to having high cost of production, or a farm receiving a lower price for its product. Thus, a low OPM points at either cost control and production efficiency issues, and/or price and marketing issues. Addressing these will help increase your beef operation’s performance and possibly its profitability.
Your farm accountant can help you with assembling your Balance Sheet and Income Statement to calculate these ratios. Your UW-Extension agriculture educator can help you benchmark your ROA, ROE and OPM to other beef farms. Comparing yourself to others begins the discussion concerning the overall management of your operation. Beef management, including financial management resources, are available from the UW-Extension Beef Information Center in the Decision Tools and Software Section.