Here is a typical family farm operation: Mom and Dad have been farming for years and are looking at turning the operation over to the next generation. The farm is paid for and now they would like to retire and sell that to the next generation. We all know there are plenty of human resource complications with this process. It can get complex, stressful and even messy. I would highly recommend getting some help with succession planning if you’re in that situation. Today, however, I would like to look at an economic complication of this situation.
Mom and Dad have been farming for years. They are supporting one household just fine and have plenty of cash flow. They pay all their bills and get to take a few vacations each year. They are comfortable.
But remember that there are two sets of numbers in a business. The economic side tells you if the business is profitable. This, I work out with a gross margin analysis. The financial side tells me if I can afford to do it. This I run with a monthly cash flow. Financially, Mom and Dad are doing just fine but my question is: is your farm repeatable? What I mean by this is can the business be purchased by the next generation and be run exactly the same way? Is the business economical as well as financially stable?
Another way to look at it might be: is your farm franchisable? Is it a business that has the potential to be sold as a franchise opportunity? This would generally be a business that is established, offers a unique concept that is teachable and can provide an adequate return. In other words, the business plan has been built and proven to work. You are handing down a recipe for success.
For a business to be repeatable, it needs to be both economic and financially stable. Mom and Dad have worked very hard, maybe even struggled a bit over the years. Now they deserve the retirement that they worked so hard for. But, as Joel Salatin, holistic farmer and author, says, what got you here, won’t get you there. Farming has changed and the new generation faces a different set of circumstances while running a farm business.
Please don’t take this the wrong way but a lot of existing farm businesses have been built up over the years by a combination of five subsidies:
1. Off-farm income. This has been quite common in agriculture, and still is. It’s when one or more of the farm members needs outside income to keep the farm afloat. I want to be clear that there is a difference between a farm being too small to support the household, and the farm needing the off-farm job to support the farm. As long as the money from the job is only partially supporting the household and the farm is partially supporting the household, that is not an off-farm job. The farm is contributing to the household. I would consider it a subsidy if the off-farm job is injecting money into the farm to keep it afloat.
2. Unpaid labour. This is another form of subsidy. A lot of people do not account for their labour on the farm. What is your time worth working somewhere else? We need to be paying for our time.
3. Government subsidy. This, of course, refers to all of the funds, insurance, discounts and grants that we as farmers receive through both our provincial and federal governments. You have to admit, we get some pretty helpful assistance from our governments.
4. Inheritance. This is a form of subsidy that we usually don’t account for. We are handed down some equity in one form or another that allows us to continue farming the way that we do.
5. Land appreciation. This is the big one that has allowed many farms to continue operating. Our land appreciated in value which makes our balance sheet look better. It gives us more borrowing power and allows us to make up for losses elsewhere in our businesses. In reality, a lot of our farm profit was made in real estate investment.
Don’t get me wrong, I am not discounting all of the hard work and dedication that the previous generation put into building up their farms. The point I am trying to make is that this generation can’t do the same things and expect it to work out the same. They’ll need a new plan. A business is not repeatable if it relies on these subsidies.
This is why our gross margin analysis needs to include opportunity cost, depreciation, inflation and labour costs. If your farm can still show a profit after covering all these things, your farm just might be repeatable.
Opportunity cost is a measure of your management. You don’t see it in your finances, but you need to account for it in your economics. Look at it as an interest charge on that investment. That money could be earning you a return somewhere else. In our example, Mom and Dad have all their land paid for. They currently do not have any payments associated with that land and have no land rent. Financially, they are comfortable. However, if we sell the land to the next generation, even at a discounted rate, that payment will have to come from somewhere. That payment might be the same money that Mom and Dad might use for the holiday.
In addition, the value of the land today is a lot higher compared to the agriculture production ability than it was 50 to 75 years ago. How does the next generation operate the farm when they have an extra payment or two to make and that payment is bigger? This could be on land, livestock or equipment. Usually the truth is, they can’t. It can’t support the same household without even more subsidy. It is not repeatable.
Depreciation is the loss in value of an asset over time. It is calculated by subtracting the salvage value of an asset from the purchase value divided by the number of years owned. Most of our equipment depreciates but our livestock can also depreciate. In theory, every year, the depreciation value of an asset should be accounted for and saved. When the time comes to replace that asset, you use the money saved up plus the salvage value of the asset sold, to replace it. Do you think Mom and Dad are covering their depreciation each year? Not usually because when it comes time to replace that tractor, they have borrowing power because the land has appreciated.
We also need to cover inflation. Will the money you have today be worth the same tomorrow? We have to make sure our businesses will be ahead of where they are today, 10 years from now, by accounting for inflation in our economics. It’s one more cost that the new generation needs to plan for.
I have had many farmers tell me over the years that you can’t account for your labour or you will never make any money. This idea has to change. My farm is a business. It needs to be treated like one. I will admit, some years I do not get paid as much as I plan to, but the important word is “plan.” I cannot control the majority of the conditions on my farm but I want to go forth with a business plan that pays for my labour.
My message here today is for all the moms and dads, all the established farmers wanting to retire and sell the farm to the next generation. Is your business repeatable? Would you be able to buy another farm, with all the payments associated with the land, equipment and livestock, and run your farm the same way you do now? Is your farm economically as well as financially sound? That is the reality for the next generation.
My suggestion is to try to make your business repeatable, not just comfortable. If you make your farm franchisable, that is the best gift you could give to the next generation.