It’s common for food-service providers and retailers to communicate they are committed to sourcing food from sustainable beef production systems. Most sustainability definitions note the necessity of an economic or financial component.

The challenge of measuring financial and economic sustainability at the ranch level is not effectively communicated.

The necessity to have information to determine if changes in ranch production and marketing systems are economically viable is seldom mentioned.

Changes can be proposed without economic evaluation of their profitability. Many changes are cost-effective but lack the numbers to show their profitability.

It’s clear if a production system used by a ranch business is not profitable, producers will cease production. There is no economic incentive to maintain, invest or grow the business.

The continued historical decline in the national beef cow herd certainly reflects an industry that is not being sustained. Profitability of change will be an important determinant if this trend is reversed.

Missing the bottom line

The Internal Revenue Service (IRS) Schedule F, Profit or Loss From Farming, is the primary source of rancher financial reporting.

It’s likely that more than 95 percent of beef cattle producers use cash accounting to comply with IRS rules. The schedule F does not measure profitability of the business or economic sustainability.

Often inventory change, prepaid expenses, receivable or payables mean cash reporting does not measure profitability.

Following IRS rules, depreciation expenses are distorted. Producers should calculate depreciation using “book” or replacement cost with reasonable useful lives and salvage values to measure profitability.

Replacement stock should not be expensed. There is no compensation for owner-operator labor and management in Schedule F. Working for nothing does not reflect business reality.

Every other major participant in the beef supply chain above the ranch level use generally accepted accounting principles (GAAP) for financial reporting that measure profitability. These margin segments know their costs and profit margins.

CattleFax and others publish numbers on cow-calf cash profit. Cash profit is not even a valid financial performance term. Profit is after all expenses are accounted for.

CattleFax leaves out depreciation and returns to owner-operator labor and management. These are major costs at the cow-calf level and are completely inconsistent with GAAP accounting use by others in the supply chain.

CattleFax cash profit cannot be used to calculate business return on assets (ROA) or return on equity (ROE), fundamental measures of financial performance.

The methodology to measure financial or economic sustainability certainly needs to do more than use the IRS Schedule F cash-based reported “profit or loss” to define profitability.

This was addressed in the standardized performance analysis (SPA) methodology adopted by the National Cattlemen Association (NCA) in 1991.

The accounting methodology used in SPA followed the Farm Financial Standards Council guidelines (FFSC). These methodologies use accrual adjusted incomes measures of profitability.

There are some additional data required beyond what is necessary for compliance with IRS cash reporting using the Schedule F to prepare the business accrual adjusted financial statements that measure profitability, including:

• Beginning and ending fiscal year cattle and feed inventories
• Other data for accrual adjustments including prepaid expenses, accounts payable and receivable and accrued interest and taxes
• Owner-operator labor and management compensation equivalent to hired services
• Market value of capital assets for the balance sheet and loan balances and payments due
• Completing the IRS schedule does not require a business balance sheet. The FFSC recommends using a market-valued balance sheet.
• Replacement cost for capital assets or depreciable assets including purchased breeding cattle, vehicles, machinery and equipment, and land improvements including buildings
• Base value or estimated cost of producing replacement stock (FFSC)
• Closeout information for retained ownership stocker, background or finishing activities
• For the CPA to calculate “book” depreciation using the IRS depreciation schedule, the rancher needs to provide expected economic life and salvage values of all capital assets. Care must be taken on the use of IRS Section 179 “bonus” depreciation and trade-ins that reduces cost basis of capital assets.

Data to measure economic profitability

• Raised feed at market value at the beginning of the feeding season
• Land cash lease rates
• Operating and non-real estate capital opportunity cost

This takes some additional effort, but knowing profitability is extremely important for any business. Effective use of accounting systems like QuickBooks certainly supports this effort.

A business cannot measure financial performance or sustainability without this information that goes beyond cash reporting for the IRS.

Suggested definitions of financial and economic profitability for measuring sustainability are as follows:

Financial profitability
Financial profitability is measured by calculating the accrual adjusted revenue and expenses reported in the business accrual adjusted income statement or profit or loss (P&L) statement.

Raised feed is valued at cost of production. Breeding stock replacement cost is calculated using either the FFSC base value or the GAAP full cost absorption method.

Depreciation of capital assets is either by calculating “book” depreciation or capital recovery based on replacement cost. Hired labor and management compensation equivalence is used for owner-operator compensation.

Interest is the cash paid and change in accrued interest. Financial net income or profitability and return on assets (ROA) are for a fiscal year and does not include real estate value appreciation.

Economic profitability
Economic profitability is measured with the same financial accrual adjusted information with the additional adjustments of an opportunity cost for land and improvements (cash lease minus property tax and maintenance cost not covered in a cash lease), raised feed at market value, and operating and non-real estate capital valued at opportunity cost.

The opportunity cost of capital is a return expected on the next most profitable return on investment with similar risk. Economic profitability and return on assets (ROA) are measures of the economic consequence of entry or exiting the business.

The best measure of sustainability is economic profitability because individual business financial sustainability is heavily influenced by the owner equity and repayment capacity position.

For published comparative benchmarks, evaluation of ranches, systems or practice purpose profit measures are pre-income tax and do not include appreciation of land. Of course, the rancher should use both measures of performance, as done in SPA.

With the volatility in commodity prices and production cost, a sustainable business does not have to be profitable every year.

A lender would like to see financial profitable performance and ROA for the past three years and a business plan that can demonstrate cash flow and profit potential for five years.

It’s not often they get this information. The business debt situation and repayment capacity are critical considerations for an ongoing or sustainable business.

By a business definition, the cow-calf sector is not being sustained. The sector has the smallest beef cow herd since 1941.

It’s going to be a challenge to measure an “economically sustainable” price level for cow-calf producers and impacts of alternative production and marketing systems that change environmental, social and consumer-desired dimensions of sustainability.

The reporting and communication burden is on the ranch sector because others in the beef businesses in the supply chains have in place their reported standardized measures of profitability.

Others in the supply chain will not take the responsibility to measure ranch economic sustainability of changes they wish to impose on producers. 

References omitted due to space but are available upon request. Click here to email an editor.