Life is Full of Difficult Choices: A Tale of a Financial Management Decision
Farm Business Management Update, October/November 2005
By Keith Dickinson, (Keith.Dickinson@vt.edu), Extension Agent, Farm Business Management, Northern District
I loved my 2002 Dodge Ram Pickup. Notice that I said "loved"... past tense. The pickup is gone. I now drive a 2002 Nissan Sentra. Talk about your dramatic changes! I'm not so crazy about driving this small car. It's small... not at all intimidating on the road like that big old Dodge was. Why, but why, you might ask, did I ever sell that truck, if I enjoyed it so much?
The answer to this question is simple. I concluded that I could save myself nearly $4,000 a year by making the switch. Although I loved driving that truck, (I think that I actually enjoyed owning the truck more than I did driving it!) that enjoyment was not worth $4,000. My savings will primarily come from the savings in gas, but also from a reduction in monthly debt payment, insurance costs, and even personal property taxes.
Farm managers are faced with rising costs of operation. Fuel, fertilizers, equipment, pesticides and other inputs are rising substantially in price. Unfortunately, commodity prices are not keeping pace. Therefore, farm managers need to find ways to trim costs to remain (or once again become) profitable. The solutions that managers come up with may be complex and could have a significant impact on the way that they operate their farm. Two key questions to ask are
In my example, I was certainly not operating a farm business with my pickup truck, but it was my main method of transportation to and from work, as well as to client's farms, etc. To evaluate the impact of my decision to switch to a compact car, I needed to think about everything that I used my truck for on a regular basis and whether or not a compact car could accomplish those same tasks just as effectively. With the exception of needing to change my landfill schedule (I own several garbage cans, so that I can delay that job as long as possible), I realized that my normal use would be satisfied with the car. A plus is that I'm no longer on the "short list" for assistance when an acquaintance moves!
Farm managers should look carefully at what impact a decision to change a part of their farming operation will have on the rest of their businesses. For example, it would be very tempting to reduce the rate of fertilizer applied next spring, but the obvious negative consideration is that crop yield is likely to be reduced. However, since most crop yields have diminishing yield returns to additional fertilizer applications once a certain point has been reached, it may be appropriate to analyze very closely the fertilizer program and see if indeed areas can be trimmed. A local extension agent or nutrient management specialist can help evaluate fertility programs and give recommendations for adjustments.
A more complex example of the impact of a cost reduction decision on the farming operation could be if managers decided to eliminate making their own hay and relied on purchasing hay. The managers would need to evaluate whether the purchased hay would be of the same quality, and if not, if it would supply their livestock with adequate nutrition. Otherwise, a reduction in performance could occur that might lead to a loss in income.
The more important aspect of my decision was the savings vs. cost question. I used a modified form of a partial budget to make my decision. A partial budget can be a very useful tool for making a management decision. In a partial budget, the positive financial effects of a decision are listed in one column, and the negative financial effects of the same decision are listed in another. The net result is a positive or negative number, which leads the manager to the "bottom line" of the decision. See my example below.
|Partial Budget: Sell Truck and Buy Car|
|Positive Effects||Negative Effects|
|Decreased Fuel Consumption = 28,000 miles / year divided by 14 MPG (Dodge) = 2,000 gallons / year times $2.60 / gallon = $5,200 MINUS 28,000 miles / year divided by 30 MPG (Nissan) = 933 gallons / year times $2.60 / gallon = $2,425 = $2,774 Net Savings / Year||Loss of personal enjoyment of owning a pickup truck = $789 (my estimated value)|
|Decreased Insurance Cost = $ 500 / Year (approximately)|
|Decreased debt payment = $720 / Year (+ payoff will occur 8 months earlier)|
|Total Positive Effects = $3,994||Total Negative Effects: $789|
Increasing costs and limited returns will create challenging financial times for many farm managers in the coming months and years. Changes may need to be made to production systems to maintain viability. The use of sound financial tools and advice are critical in making good business decisions. Farm managers should consult with their local farm business management agent, lender, accountant, or other financial advisors prior to making major changes to the business, in order to properly evaluate impact of decisions.
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