Strategy and Planning

Profits = E + W + G + I

Just as E = mc2 symbolizes the incredible potential of atomic energy, Profits = E+W+G+I lists the factors that are vitally important to your farm's bottom line.

The formula was developed by David Kohl, an agricultural economist currently serving as advisor to RBC Royal Bank. His formula says: (P)rofits = (E)xports + (W)eather + (G)overnment policy + (I)nterest rates. These factors have always been keys to farming profitably, but he believes they will be even more so in the future.

Here's why: the 1990s winnowed out a lot of operations in North America. In 1998, only 20% of North American farms generated a profit! In other words, production, investment and expertise are beginning to concentrate. It's an international trend. And when resources are concentrated – risk goes up. You can compare it to putting all of your eggs in one basket.

Kohl calls this trend "new-era" risk and, to manage it, you must look far, far beyond your fencelines to identify opportunities and threats. That's why he came up with P = E + W + G + I, and here's how it could impact your farm:

Exports. Spotting trends as they develop can mean the world to your bottom line. For example, farm managers who think globally know that Japan's economy is showing signs of a recovery. The stock market is rebounding; there's increasing consumer confidence; and the exchange rate between the Yen and U.S. Dollar is starting to favour exports.

Japan represents about 70% of the Asian market. And the narrowing ratio between the Yen and U.S. Dollar is good for exporters. What do Japanese consumers want, and what opportunities exist for your farm?

Weather. Today, seven key food-producing areas in parts of Canada, the U.S., Australia, Europe, South America, Asia and southern Africa produce 75% of the world's food. If drought or flood hits any one of them, the ramifications can be global.

If you raise cattle and weather devastates Iowa's corn crop, what's going to happen to your feed costs? Although our local weather is important, watch for sunny skies or storm clouds around the world as well!

Government policy. The Canadian and U.S. economies are strong, and food is cheap! But Kohl suspects there's an 80% to 90% chance that the incoming U.S. President will inherit a recession. And when times get tough, public attitudes toward subsidies harden, and that includes U.S. government subsidies for agriculture.

The same events could occur in other food-producing regions. If that happens, the agricultural playing field will become much more level. And a level playing field will open export opportunities for Canadian farmers.

Interest rates. About 75% of North American farm debt is carried by 20% of the operations. And for every 1% increase in interest rates, net farm income drops between 6% and 8% as more income goes toward debt-servicing.

Interest rates have gone up about 1% in the past year or so, and Kohl anticipates that they'll go up another 1% over the next year. If rates are headed higher, is your farm vulnerable? Tracking interest rates could help you soften the blow whenever they move higher.

* Dr. David Kohl is a highly respected teacher, author and speaker. He is presently serving as advisor to RBC Royal Bank management, staff and clients while on leave from Virginia Tech University in Blacksburg, where he is a professor of agricultural finance, and small business management and entrepreneurship.