Manitoba Agriculture, Food and Rural Initiatives

Benchmarking Financial Performance

John Maltman, Fred Hardy, Swine Specialist Farm Management Specialist

We can get lost in terminology when trying to evaluate our pig farms. Economic downturns can raise the profiles of financial terminology while new products are promoted on the basis of improvements they make in measures of production such as rate of gain (R.O.G.) or feed efficiency (F.E.).

From time to time, new terms also arise because of the need to have a measure of performance from both a production and financial standpoint. When contradictions occur regarding production levels versus financial performance, often the cause is differing definitions or not having a full understanding of the terms and how they are related.

Production terms are vital in the day-to-day processes on the farm. Farmers and managers need to measure performance parameters and compare them with standards in order to progress. Historical data trace the development of the herd and can signal when the farm is not proceeding in the expected direction. If sufficient raw data are collected, an in-depth analysis can be revealing. Micro decisions can be made in the context of the overall farm plan.

However, many production decisions have been made in isolation from the overall financial framework. Production and financial information were viewed as separate bodies of knowledge. Integrating them was a separate activity often left to the lender. Confusion with terminology in both areas made decision making difficult and slowed the flow of money into the industry.

In order for lenders, investors and farmers to have comfort with the pig industry, they need to understand the significance of terminology and be prepared for the natural ups and downs as far as they can be anticipated. Production terms can best be used and understood by those involved on a daily basis with pigs. Managers today must understand both the financial and production terminology and also know the financial implications of production changes.

Feed efficiency (F.E.), for example, can be manipulated by changing particle size of ingredients, raising or lowering the digestible energy or limit feeding the pigs. High levels of performance in all areas are importance but are subject to the laws of diminishing returns. Theoretically, all healthy piglets born could be saved if no limit on labour or technology is in place. Higher performance figures can be achieved with a higher input of money.

Experienced managers know that historically a hog cycle exists and that ignoring the implications of overspending on technology or labour has punishing financial consequences.

Lenders know that the answer to financial difficulties is not always to advance more money. Their comfort comes in using terms that measure production in debt related numbers. They focus on a farm's ability to repay debt, given their current production levels as plotted against current position in the hog cycle.

One common ratio that measures financial performance is to divide operating expenses by the operating revenue and express it as a percent. Financial data collected from pig farms across Manitoba for the years 1995-98 found a dramatic difference between operations in relation to the percentage of operating expenses to operating revenue. Operating expenses included hired and family labour and all other costs excluding loan payments and property taxes. They found half of the farrow-finish producers in the range of 60-89%; the overall average being 72%. However, a quarter of producers had a ratio of operating costs to operating revenue below 60% and a quarter had over 89%. The ranges for farrow-weanling had half of the farms between 72% and 93%, feeder barns had half of the farms between 67% and 84%. Remember, a quarter of the producers in the study were below these ranges and one quarter were above. The study did not determine the reasons for these differences.

An operation's expected total cost of production, including both operating costs and debt servicing, must be clear. An operation may have a low operating cost ratio but still have very high debt payments. A projected total cost of production of $1.36/kg or 62¢/lb is acceptable to most lenders. Creditors are adhering to their financial benchmarks more than ever. Here are some of their financial ratios:

The suggested maximum debt for feeder barns is $225/pig place. This amount includes both term and operating loans. The maximum term debt payment is 15% of operating revenue, while the average historical expense ratio is 79%. Producers can be rated above or below these standards, depending on such factors as age of facilities and management ability.

The challenge is to find the balance between potential benefits and the associated costs and risk to produce the lowest cost per kilogram of pork sold.