Better Decisions
June/July 2000
Working on relationships brings tremendous returns
Conflict and communications can play havoc with farm families if not handled properly
by ROB GAMBLE
I just bought a new calculator, which calculates lease and mortgage payments, cash flows, margins and markups, to name just a few. It's very impressive. However, it doesn't calculate the impact of a bad relationship on the bottom line of the business. There doesn't seem to be a button for that. Perhaps the next model will have one. You know, enter the age of the person, their equity in the business, personality type and press B2 for "Blowup." And the answer is $236,345. If the number gets too large the calculator reads, "Your business is toast!"
Nobody thinks about relationships in terms of dollars, but you should.
The Top 10 Sources of Stress in Multigenerational Farms
Note that only two of these sources of stress involve money!
Relationships are valuable -- so valuable that, throughout history, they have been regarded as beyond monetary value. Consider the proverb that says "Better a dry crust with peace and quiet, than a house full of feasting with strife."
Money is secondary when it comes to good relationships.
You might be wondering how this ties into a column on decision making. It's simple really. Just as you decide what you're going to plant this spring, you also have to decide what you will do to strengthen your relationships.
More and more, I find myself talking to groups and individuals about the key issues they face with family relationships in the business. The discussion often starts with the financial
numbers, but then turns to the relationships. If you don't think it is
important, check out Table 1, which was taken from a U.S. study of farm families. Monetary issues make up only 20 per cent of the sources of stress.
There are two main relationship issues. One is communication. The other is conflict. Try taking the communication quiz and see how you score.
If you scored low you might want to try what I call the "Five Second Rule." Just wait five seconds after the other person is finished speaking before you reply. You will be amazed at the additional information that comes out because of that pause. People want to be understood, and giving them the time to be heard helps them to feel that. You will strengthen your relationship with them, and become a better listener.
Conflict is a close cousin to communication. Sometimes we assume that all conflict is negative. This is not true. If handled correctly, conflict can lead to very creative solutions. However, if handled improperly, it creates a separation between the parties involved. In business this can be fatal. You must attempt to handle conflict properly. Here are some guidelines to follow:
1. Attack the problem, not the person.
2. Focus on your shared goals.
3. Listen attentively.
4. Speak carefully so that you are sure you are understood.
5. Conclude the conflict.
You also need to remember that not all conflict can be resolved. Sometimes you must simply agree to disagree, or settle on separate farming operations. A good decision may mean keeping the family relationship and severing the business one.
If you make the decision to work on relationships, I'm convinced the returns will be tremendous. And, you can use your calculator for cash flows and skip the new model with the B2 button on it.
So you think you have relationship problems? You're not alone. These are a list of just some of the comments I've heard from families over the years.
Dad won’t take my advice.
My son won’t take my advice.
Nobody will take my advice.
My parents won’t show me the books.
I don’t know when the farm will transfer.
I don’t want to quit farming yet.
I am afraid I will lose control of my retirement funds.
I can’t get along with my brother.
I don’t think my son can handle the business.
Our daughter-in-law is influencing our son.
My dad says everything will work out.
Do you have the name of a good lawyer!
The good news is that many of these comments reflect a lack of communication. That's good, because there are strategies you can learn to improve communication and build relationships.
Rob Gamble, is a Program Lead in Finance and Business Structures with OMAFRA. He can be reached at 1-888-466-2372 ext 64350 or by email at rgamble@omafra.gov.on.caFebruary 1, 2000
How to improve five percent on your machinery costs
By ROB GAMBLE
Someone once said that in order to succeed you only need to be five percent better than everyone else in a lot of areas -- not just 25% better in a few.Last month I wrote about the cost of machinery. You might have wondered if there are some average machinery costs to compare your own with. There are.
Take a look at the first chart. These are figures from the 1998 Ontario Farm Management Analysis Project (OFMAP). These are real farms but, remember, they are averages. The swine group in particular is small, made up of just 23 farms, which means there can be a fairly wide variance within that group.
However, the figures reveal one thing: a huge investment in machinery won't kill you if it's spread over enough acreage
There are some other trends that the complete data reveal:
* Cash croppers have doubled their acreage over the last five years.So how do you get five percent better in your machinery management? One way is to consider your options around machinery replacement. You can:
* The highest earning cash crop farms have $53,000 less equipment and spend $6,800 more on custom work and equipment rental. Higher revenues per acre helped put them in this top group, but these other factors can't be overlooked.
* Repair;Trading or repairing has been around a long time, but leasing is gaining in popularity with many farmers.
* Trade and buy new or used;
* Lease or rent;
* Hire custom operators.
It has some definite benefits. Usually it requires less cash flow than buying. Nor does it affect your balance sheet, because lease payments show up as an expense. For equity strapped producers, this can be important.
It has some downsides as well. It's usually more expensive from a total cost point of view. And it can be difficult to determine if you are getting a good deal.
Let's look at the last point in more detail. For the past few months, I have been collecting lease calculators. They seem to be everywhere. The major problem is they all give you different answers. And, worse, I don't always know how they are making the calculations. You can decide to just pick one and trust it, but if you are making a major decision, it would help to know how you came up with the answer!
So here is my simplified version. It's cash-based with some after-tax calculations, for you have to consider tax when comparing leasing to buying. There are other factors to consider, such as hourly use and penalties, the value of purchase options, and interest rates used to calculate the lease. But I am going to ignore them for the sake of this example.
My Example
I've used a straight lease comparison with no purchase option or penalties. On the purchase side, I assumed
* a resale value of $50,000;
* depreciation of only $50,000. CCA tax rules allow more, but then I would need to consider recapture.
Valuing the asset three or four years in advance is, of course, the trickiest part of the calculation. If the lease has a purchase option value stated, you could consider using that as your value for the sale calculation.
Results
As you can see the leased equipment comes out ahead on cash flow, but behind in actual after-tax cost. This is the most common result, but not always. The key is compare and make sure you do five percent better.
Rob Gamble, is a Program Lead in Finance and Business Structures with OMAFRA. If you would like a package on leasing decisions or a look at the lease calculators, check the web site under Better Decisions on the Agriculture/ business development page at www.gov.on.ca/omafra, or call Rob Gamble at 1-888-466-2372 ext. 64350, or email rgamble@omafra.gov.on.ca
January 1, 2000
What you need to know about machinery costs
Equipment can eat you alive. Before you buy, count the costBy ROB GAMBLE
This column may be too late, but I hope not. By the time you read this, the year-end will have passed and the urge to reduce tax by purchasing machinery may have overtaken you. Let's hope you bought fertilizer instead.Now there's nothing wrong with buying machinery as long as you know what it's costing you.
I have encountered a growing number of farmers in the past five years who are experiencing what I call the "input squeeze". Rising inputs and flat returns. The farm inputs chart on this page tells the whole story. It shows the indexed price of some equipment inputs based on a 1986 baseline.
Note how in the early 1990s most items started to rise faster than inflation. Also note farm product prices are flat! Bottom line: equipment can eat you alive. Before you buy, count the cost.
You'll need to know three things:
1. Purchase price 2. Trade in value 3. Annual CostsPurchase price is the easiest. Generally equipment sells for between 80 and 90 percent of the list price.
Trade in value is the hardest. If you plan to keep a machine for five years, how can you tell what will it be worth then? One way is an educated guess based on the current used prices. Not a bad method. Another is to use a percentage of the purchase cost figure based on machinery tables put together by the American Society of Agricultural Engineers (ASAE). What they don't account for is the level of use and or the condition of the machine.
The difference between these two (purchase and trade in) is that shocking figure called depreciation.
The last figures you need are the annual costs. There are two categories: operating and fixed. Operating costs are fuel, lubricants, repairs and, optionally, labour. You can estimate repairs based on your actual records or by using ASAE machinery charts that estimate the repairs based on hourly usage. Fixed costs are depreciation, interest, insurance and housing. Use 1.5 percent of new cost to estimate the yearly insurance and housing and use the T-bill rate to estimate interest cost. The tractor example in the second chart shows how to make the calculation.
Two final points:
1. Attempt to use your machinery fully. I'm always amazed to drive past construction sites during the summer and see a million dollars of equipment sitting idle. Sometimes it can't be helped, but try to maximize the use of your machinery. It reduces your fixed cost per unit.
2. Options for leasing equipment are becoming much more popular. In some cases it's a good deal, in others it's not. Calculating your costs of ownership can help you decide. The same is true for repairing machinery or having custom work done.
So don't move that fertilizer in the shed just yet. At least not until you've done some calculations.
Rob Gamble, is a Program Lead in Finance and Business Structures with OMAFRA. The tables referred to are on the OMAFRA Web site at www.gov.on.ca/omafra under Business Development. Look for Budgeting Machinery Costs or call Rob Gamble at 1-888-466-2372 ext. 64350 or email rgamble@omafra.gov.on.ca
December 1, 1999
Better Decisions
What is land really worth?
By Rob Gamble
I have just returned from an American bankers' conference where they talked about land prices. For the most part, everyone talked about a relatively stable trend as long as the stock market stays strong. That's because the market is funding the purchase of recreational property. In fact, some valuators told me they are using a "dollars per mile of fishable stream" as a valuation method.That said, we might as well tackle one of the biggest decisions a farmer can face. Do I purchase land and how much can I pay? Perhaps the more appropriate question is how much is it worth?
Land can be valued in three ways: productive value, economic value and market value.
Productive value is determined by the profits the land can produce. Gross income per acre, minus cash and non-cash expenses (not including interest) gives you the profit figure needed for our calculation. (A plug here for good records. No matter how you estimate the value of land, any method relies on coming up with accurate revenue and costs. In both cases, be conservative.)
Next step is to decide on a figure that represents the after-tax return that you would expect on a "riskless" investment such as GIC's or bonds. You might ask, what does this have to do with purchasing land? Well, you can decide not to purchase land and invest your money elsewhere.
Now, the calculation. Divide the net profit by the discount rate to arrive at the productive value.
ExampleThe details:
* The land is priced at $2,000 per acre;
* estimate that your profit per acre would be $60;
* you decide on a 5% discount rate;
* you estimate that you will keep the land for at least 15 years.Calculate as follows:
Net profit per year per acre
Discount factor= 60/.05 = $1,200 per acre
There are two shortcomings with this method. It doesn't account for how long you own the land, and it assumes cash received in 15 years is as valuable as cash received today.
How do you solve these problems? One way is to convert all of the profits into today's dollars. Using an annuity table to convert these payments, we find that $60 per year for 15 years at a discount rate of 5% is equal to $622.56 in today's dollars. When we divide that by 15 years, it works out to $41.50 per year. The same calculation as above gives us:
Discounted Net profit / year/ acre
Discount factor= 41.50/.05 = $830 per acre
The take-home lesson is that productive value is usually well below market value. You would need, using our example, $207 of profits per acre per year for the productive value to equal the market value. Clearly something is missing here. That's where economic value comes in. The missing piece is capital gains. Factoring in the expected gain on the land gives us the economic value. I use a slightly more complex calculation in my case study; by modifying our previous calculation we can get a reasonable estimate. Subtract the after-tax capital gain you expect from the discount rate. If you use 3% for the capital gain, the calculation now looks like this:
Discounted Net profit / year/ acre
Discount factor= 41.50/ .05-.03 = 41.50/.02 = $2,075 per acre
You can see now what fuels land prices. Some of it is related to crop prices but a lot is capital gain. The problem is, future capital gains don't pay the bills. The method I used in this example doesn't work well if you expect inflation to be higher than the discount rate. Taxes should also be accounted for. To do this, you need to use present and future value tables.
Of course other factors affect the value of land. Market value is affected by demand. Equipment capacity, labour, the ability to manage extra land, and cash flow all influence the decision.
But next time you see land for sale, ask yourself, what is it really worth? Do some calculations and make a better decision.
Rob Gamble, is a Program Lead in Finance and Business Structures with OMAFRA. If you would like a package on land purchase decisions call Rob Gamble at 1-888-466-2372 ext 64350 or email rgamble@omafra.gov.on.ca
© copyright 1999 AgMedia Co-operative Inc..
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November 1, 1999
Anticipation is critical
By Rob Gamble
My eight-year-old son recently learned to play chess. The other night he nearly beat me. Now you're thinking: Do I really want to read a column by a man who can barely beat his eight-year-old at chess? I should add that he taught me how to play just a few weeks ago, and I have learned two things about the game in my limited experience. The first is that you must think ahead and anticipate your opponent's moves. The second is that once your hand touches a particular piece you have to move it.Both of those lessons also apply to farming and the subjects that I want deal with in this and subsequent columns.
Farming requires that you look ahead and make decisions. As in chess, you have to make your move. I want write about how you can make better decisions. Over the coming months I will look at some of the critical decisions that farmers are facing. Quota and land purchases, expansion, diversification, equipment and capital purchases are some that come to mind. In each column I will give you some opinion, some tools for making calculations and the opportunity to have me send you some follow-up information.
What is a decision?
My dictionary says a decision means "to arrive at a solution that ends the uncertainty". Unfortunately, I disagree with Mr. Webster. Making a decision does not always end the uncertainty. We often have to live with a great deal of uncertainty even after a decision is made. Economists call this risk. And risk is the chance that the outcome of our decision will be negative.There are usually some things we can do about this potential negative outcome we call risk. The first is deciding how much risk we want to take. Each of us has levels at which he is comfortable. But we also hold attitudes that might surprise you. I discovered some of mine by answering the three questions in the risk quiz. (See insert.)
How Does this Apply?
Real-life decisions are much more complex than the risk quiz of course. However, I would like to give you two suggestions for better decision-making.1. Information - mostly your own records! How can you assess the likelihood of a negative outcome if you can't look at the past? You must have timely, relevant information on your business to make good decisions. There are other sources of information, but your own is often overlooked. If you don't have a good record system, get one, now.
2. Goals - "right," you say, "been there, heard that, I have no control anyhow!" Think about it for a moment. When was the last time you made a decision without any purpose? We always have a goal in mind. The problem is, these goals are sometimes too vague to allow for a strategy to reduce risk. I am suggesting that clear business goals help you make clear decisions.
But studies show that long-term goals alone don't motivate us. A series of short-term goals that get us to our long- term objective is the best approach. And you will always have some conflicting goals. Then you, your family, your business partners will have to work them through.
Rob Gamble, is a Program Lead in Finance and Business Structures with OMAFRA. If you would like a package on decision-making and the issues talked about in this column, call Rob Gamble at 1-888-466-2372 ext 64350 or email rgamble@omafra.gov.on.ca, or you can find the information on the website at www.gov.on.ca/omafra under Business Development
© copyright 1999 AgMedia Co-operative Inc..
The Risk QuizWhat are your attitudes towards these risky situations? Choose A or B
1. Imagine you are given the choice betweenA. A sure gain of $700.
B. A risky prospect that offers a 75- percent chance of winning $1,000 and a 25 percent chance of winning nothing.2. You are given the choice between
A. A sure loss of $700.
B. A risky prospect that offers a 75-percent chance of losing $1,000 and a 25-percent chance of losing nothing. Which option would you select?3. Paul has an investment in money-market funds. During the past year, he could have invested this money in the stock market, and he would have been $25,000 ahead. Unfortunately, Paul retained his money-market funds. Dave had an investment in the stock market. But last year he sold all his shares and invested in money-market funds. His investment is now worth $25,000 less than it would have been if the stock had been retained. Who feels worse?
A. Paul
B. Dave
Your AnswersHow do you compare?
Question 1
Most people opt for answer "a", the sure gain. Even though answer "b" provides a higher average or expected value if taken repeatedly, most individuals are risk-averse ) with respect to gains. Most people prefer a smaller gain that is certain to a larger gain that is uncertain.Question 2
Most people pick answer "b". Again, if taken repeatedly, answer "b" has a higher average or expected loss value ($750 vs $700 for answer "a"). Most people are risk- seeking when it comes to losses. We prefer to take a chance (hoping that we lose nothing ) rather than accept a smaller certain loss. Would you hesitate to lock in a sure loss by forward-contracting for a price below your cost of production? Or do you prefer to take the risk prices might increase, even though the probability is greater that even larger losses will occur.Question 3
Who feels worse, Paul or Dave? Most people say Dave. For them, the regret associated with a loss from taking an action is greater than that from inaction. This principle helps to explain why the loss associated with selling corn at $2.50 and seeing the market go to $3.00 is more painful than not selling at $2.50 and seeing the market going to $2.00. People tend to be more critical of their decisions to act than their decisions to be passive or to do nothing.
© copyright 1999 AgMedia Co-operative Inc..