My entrance into the farm business world came by a rather unexpected job offer my senior year of college to work for our regional farm credit association.
I was an animal science major without any financial education to speak of but with enough brass to apply for the position. After the initial shock of the job offer wore off, I worried whether I’d bluffed my way a little too well into the position. The HR team assured me I was a great fit. They said it was easier to teach finance than it was to teach agriculture – and at least according to my bachelor’s degree, I knew agriculture.
One of the first tasks I was given as a newly minted credit officer trainee was creating income statements from Schedule F tax return forms. I followed the form, inputting numbers as I went down the income and expense sections. Then there was the box that said, “family living expenses.” Not knowing what that number should be, I’d look at the historical income statements and put whatever number the previous inputter had used. I was working with small to medium-sized farms and ranches, and that input number was usually $30,000 or $40,000.
A year into the position, when I completed a renewal cycle and had created a least a hundred income statements from tax forms, I attended a conference where Dr. Dave Kohl, farm finance guru, was the keynote speaker. (His real title is professor emeritus of agricultural finance and small business management and entrepreneurship in the department of agricultural and applied economics at Virginia Polytechnic Institute and State University, but that’s a mouthful). The topic of Kohl’s presentation was transitioning family farms to the next generation. He was sharing some thoughts on the financial burden for farms that are trying to support too many households.
In his talk, he shared a statistic that stopped my haphazard notes on the page. According to data compiled by FINPACK, a group of 13 farm management education programs across the country, the average total cash living expense for a farm family (average family was 3.1 people) was $112,227 in 2012. This number includes family living expenses, income taxes paid and non-farm capital expenditures. The $30,000 to $40,000 I’d been using as my fill number seemed mighty insufficient, according to Kohl’s data.
The next day in the office, I queried a more experienced colleague on this dilemma. The answer he gave was reasonable. He reminded me that farmers often expense what we might think of as “family living” as farm expenses in their tax returns. Things like insurance, fuel, eating out, travel and taxes often fall into that category. (According to Kohl, somewhere between 30% and 40% of farm expenses are also family living). He went on to say that, often, farmers and ranchers don’t have a mortgage or rent because their home is part of the operation. He said those things, together with the $30,000 to $40,000, is probably getting close to actual family living expense. When I left his office, he encouraged me to consider family living expenses based on my knowledge of the customer and to inquire from each customer what they believe it should be. I took him up on his advice and ended up in a few awkward conversations with customers who did not have any real idea what their family living expenses were.
Now this conversation happened eight years ago and, in that time, the agricultural industry has been through a roller coaster of market price, cattle prices notwithstanding. Yet personal withdrawals on farms and ranches remains high after an initial drop following the 2012 peak. In 2019, it was $89,612, from the FINPACK database.
To bring this conversation back to your operation, I’ll ask you the same question I asked my customers: Do you know what your family living expenses are? Do you know how much of your family living you run through your farm business checkbook? Or, conversely, if you are a hobby cattle producer, how much farm expenses are running through your personal checkbook? These aren’t questions for your accountant; these questions are for you, the business owner.
I will leave any tax advice to the professionals, but you should have at least a personal ledger of your family living expenses and know how much of that is flowing through the farm checkbook. My piece of advice: Separate living and business expenses so you really know how much you are spending.
This is important for all the obvious reasons of budgeting and taxes. But it is also important for the long-term future of our farm business. Kohl estimates that 40% of farm debt restructures are due in some part to an imbalance of family living expenses. Think about that: 40% of farming operations are restructured because the family needed the newest-model Suburban or they still went on the Mexican vacation even though cattle prices were only breakeven.
By actually knowing what is a living expense and what is farm expense, you can regularly examine your withdrawals. You’ll then be able to see when the balance of the two is out of whack. William Edwards, retired extension economist with Iowa State University, suggests no more than 10% of gross income to be allocated to family living – and less if you are a high-grossing business like cattle feeding.
Kohl recommends farmers follow the 60-30-10 rule. He says 60% percent of farm profits are invested in improved efficiency, 30% goes to a working capital reserve to build liquidity, and 10% is earmarked for discretionary spending or family living. He goes on to say that families who desire a higher standard of living probably need non-farm income to supplement their withdrawals.
In the COVID-19 pandemic world we are operating in, this advice is extra pertinent. In the initial wave of the pandemic, we saw commodity prices quickly drop and then slowly come back to manageable levels. Many producers took advantage of federal aid, which has pushed gross income level for the year back up, despite early losses. This might have you feeling more comfortable than you could have imagined a year ago. However, in the first six months of 2020, about 580 farmers and ranchers filed for Chapter 12 bankruptcy protection (USDA, 2020). This is 8% more than 2019. And again, to lean on Kohl, he says we probably won’t see the financial impact of this pandemic for months and maybe even years. It’s probably time (if you haven’t already) to quit relying on the historical cattle market swings to base your budget on. Nothing historical could have prepared us for 2020.
This year, of all years, it probably makes sense to seek a little wisdom from the Good Book and to “set thine house in order” (2 Kings 20:1, KJV). In the best case, you can tell your young credit officer when she comes a-knocking this spring exactly what your family living expenses are. In the worst case, it may keep the ranch afloat during turbulent markets.
