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Let’s Put the ‘Business’ into Farm Business Structures Part Three: Operational Efficiency and Financial Success

09/12/2015


So far in my blog series on incorporating better business practices into your farm business, I’ve looked at estate planning​ and matrimonial disputes. Today, I’m moving onto goal-setting and optimizing your operation’s efficiency.​​

The key to a good business arrangement is goal congruence. All parties should be motivated to make decisions and exert their efforts to maximize the performance of the entire operation.  Lack of goal congruence is the major cause of friction and frustration in a farming arrangement that could be improved. Before goal congruence can be achieved, the appropriate structure needs to be established, the division of profits needs to be negotiated and all parties must have a clear understanding of the arrangement.

Before addressing the process of setting up a proper farm business structure, it is helpful to consider some commonly found symptoms of arrangements lacking goal congruence among the involved parties. These symptoms all have one thing in common: They force the participating individuals to choose between (1) the greedy option and (2) the unprofitable option, neither of which is appealing. The objective then, is to develop an operating structure which motivates all the operators to simply do what they believe is best for the whole operation. 

  • Timing of Production 

“Whose should be seeded/sprayed/harvested first?”

Scenario 1:  There is only a five-day window to seed as the result of torrential rain and, therefore, only 30% of the crop can be seeded. Dad has 2,500 total acres to seed and Son has 1,500 acres he just rented.  

Should Dad seed Son’s?             à​Unprofitable
Should Dad seed his own?                      àGreedy

Scenario 2:  The harvest is finished with the exception of 640 acres of chickpeas of which 320 are Son’s and 320 are Dad’s. Mom and Dad have already gone south for the winter and snow is coming tomorrow.

Should Son combine Dad’s chickpeas?         àUnprofitable
Should Son combine his own chickpeas?                  àGreedy

  • Grain Binning/Blending/Wholesale Marketing Decisions

Scenario 1:  Son’s wheat has now been harvested and his bin is approximately two-thirds full. Dad’s wheat is now to be harvested.

Should they worry about keeping track of every last bushel by starting a new bin for Dad and, consequently waste 2,000 bushels of storage?

Should they use up the remaining one-third of storage with the intention of remembering that when the wheat is sold or used that one-third was Dad’s? It may be uncertain as to which option is greedy but leaving a bin only two-thirds full is certainly unprofitable.

Scenario 2: Flax is early and both Dad’s and Son’s have been harvested. The local elevator is offering $2 above the market price for 1,100 bushels if it is hauled in tonight because they ran short to fill the train. An agent calls the farm and the Son answers. 

Whose flax should he sell (unprofitable or greedy)?

Scenario 3:  This year’s cereal crop is quite variable by grade and the local elevator will grade the whole farm’s crop a #2. This consists of Son’s #3 grain and #1 grain and Dad’s #3 grain. 

Should Son take the deal or try to max out his individual price with less volume?  Greedy or unprofitable? This decision does not help the whole farm make money and it is just a hassle.

  • Machinery Purchasing Decisions

Borrowing and buying decisions are complicated and somewhat arbitrary. To illustrate, consider a Son’s operation that has increased in size to the point where Mom and Dad realize they cannot afford all the machinery it requires. Consequently, Son must start purchasing the necessary new equipment. Eventually, they will alternate large purchases (“You buy the combine and I’ll buy the sprayer, etc.”). This can and has caused a countless number of poor decisions. 
For example, Son just bought a new combine and then tells Dad to buy a new tractor because he does not want to be too light on horse power. However, if the combined farm entity was purchasing the machinery and all the costs were shared, Son would be comfortable waiting for a couple years to upgrade the tractor. Son just wanted a new one because it was not coming out of his own pocket.  

The timing of all farm activities is key and there is real cost associated with a bad farm structure when Son returns home and is only farming 1,000 acres while Dad is farming 3,500 acres. Son breaks his farm into smaller fields to diversify, rotate, and experiment with his cropping.  Meanwhile, the smaller fields make the operation far less efficient when compared with a smaller number of larger fields. Additionally, because one of the goals of the parents is to transition the farm management over time, they want his attention and management skills focused on the whole operation. However, it is Son’s duty to make sure he takes care of his 1,000 acres because that is what is feeding his family. 
If Dad’s and Son’s view differ too significantly as to how the business should be run or strategic vision of the operation, it is certainly acceptable to operate separately. However, this means that seeding, spraying, and harvesting should not be done together nor should there be shared ownership of key farm machinery. The sharing of non-essential equipment is acceptable just as it would be so to share with a neighbour (such as a land roller, grain bag extractor, grain vac, etc).

Even where the operators know that the operation will someday separate, it is far better operating in a structure that encourages goal congruent decision making and has a simple and easy mechanism to determine each partner’s equity (particularly important for when the operation does separate).
All of these decisions are unnecessary, cause frustration, take time, and will never make more money for the overall farm. At best they can be neutral, never positive.  It is true that these awful choices on farms do not always result in a greedy choice. However, in those cases, the person making the decision is then in the awkward position of having to tell their spouse that they chose to give money to their partner instead of themselves today!

Other benefits of being one operational business include:

  • There is only one substantial set of records to administer.
  • Only one account for each of the farm suppliers is necessary.
  • Only one name under which to sell grain (though in rare circumstances, it may be determined that grain should be sold proportionately in separate names).
  • No need to track specific farm inputs used on each individual’s crop which is very difficult given the scale of the operations in today’s farming business where inputs are purchased and stored in such large quantities (100 tonne granular fertilizer bins, 50,000-150,000 litre liquid fertilizer bins, 450 litre totes of liquid chemical, etc). Tracking and costing these inputs is an incredible amount of work and does not make the farm any money!
  • No need to track each individual’s harvested grain when it is stored in 10,000 bushel grain bags or 30,000 bushel bins and then sold through 30,000 to 50,000 bushel sales contracts.

The establishment of an appropriate structure does not guarantee that there will never be hard decisions or disagreement. There is, however, a better chance that those decisions are important and necessary and that both parties are arguing for what they believe will make more money, not just for them, but for the farm overall. 

To learn more about goal congruence for your agriculture operation, contact Dean Klippenstine, CPA, CA, Director, Primary Producers, at 877.790.7990 or [email protected], or your local MNP Advisor.