Scraping By

I received the following email from a young rancher last week:

Dave,

I am a young rancher and have grown my herd to over 100 cows over the last four years. In addition to my own operation I earn additional income working for my Dad on his place. I owe $15,000 of my cattle loan, have land debt of about $250,000 over a 13-year term and a mortgage on our home of $85,000 with a term of 22 years. I have read and heard great things from the Ranching for Profit school but I am just scraping by and don’t know where I could get the money to attend. Can your school help make an outfit my size self-supporting? Do you have any suggestions?

Thanks,

Scraping By

Here’s my response:

Dear Scraping By,

Whether the school can help you or not really boils down to you. If you want to do everything on your existing land base it could be tough. If you are willing to look at opportunities beyond your fences there are undoubtedly opportunities.

We tend to have a paradigm that we need to own land to expand. Anyone who takes in custom cattle knows better. If your margins are good enough, putting cattle out on a custom basis or leasing cattle to folks are just two of many options for expansion without adding to your land base. Your financial situation may preclude you from pursuing those possibilities right now, but I’m sure there are other possibilities.

The way you described the things for which you have borrowed money makes me think that you are worried about your debt. Here are some thoughts about that:

1. With interest rates as low as they are, if there was ever a good time to have debt, or a less bad time, this may be it. Make sure you are getting the lowest rate possible on your long term notes and if you aren’t, refinance. Depending on your interest rates and cash flow you may want to roll your short term notes into a longer term loan, provided the interest rate doesn’t jump very much.
2. There are no one-size -fits-all financial ratios for ranches. Generally, we’d like to see a debt to asset ratio of 30% or less (there is no more than 30¢ of debt per $1.00 of total assets). The current ratio is a measure of how easy it is for a business to pay off this year’s liabilities with this year’s expected income. Many lenders like to see a ratio of 2:1 (for every $1 in income they would like to see less than 50¢ of liabilities due this year). But safe ratios for your business depend on how dependent your profitability and cash flow are on prices, weather and other factors beyond your control. It also depends on whether your is on fixed assets or working capital.
3. All of your debt is on fixed assets. That’s typical but it isn’t particularly healthy. Fixed assets are things you intend to keep (e.g. land, machinery, cows). When all your money is invested in things you intend to keep, you have nothing left to sell. That’s a huge problem. It’s why most ranchers are wealthy on the balance sheet and broke at the bank. They own an expensive collection of assets that produce very little income. Land may be a good investment, but its appreciating value won’t pay the bills. It gets worse. The problem of having a disproportionate share of your money invested in fixed assets is compounded because most of the income these ranches generate is often spent maintaining the fixed assets. It is ironic that we tend to measure someone’s success by the fixed assets they surround themselves with, yet those fixed assets are huge constraints to achieving financial success. Robert Kiyosaki drives this point home in his best-selling book, Rich Dad Poor Dad, when he calls fixed assets “liabilities”. If you want to be a ranching rockstar, building a highly profitable livestock business rapidly, it will be much more effective to have most of your money in working capital (things you intend to sell and the inputs that go into those things). That’s why it may make more sense for someone starting out to lease, rather than own, cows. It is something you may want to consider if you don’t feel you have the capital you think you need to expand the operation.
4. Most people figure that they ought to pay off debt out of their profit. Depending on your situation, it might be smarter to put your profit in income-producing investments (e.g. rental real estate, ATM machines, Laundromats, self-storage units). You could use the cash flow created from these things to pay off your debt. That way, when you are out of debt, you still have these other things creating cash flow. That could come in pretty handy when you have to destock because of drought, after all, just because you destock doesn’t mean you won’t still have bills to pay.

A lot of ranchers fear debt. When they use it to buy non-income generating fixed assets, they have good reason to be worried. But when I see a ranch that has no debt at all it leads me to wonder if there are opportunities they are missing. Having millions of dollars invested in expensive ranch land may not be the most productive use of someone’s money. As long as debt is on things that make money debt can be an extremely useful tool, especially when interest rates are low.