The three most well-recognized sustainability pillars are environmental, social, and economic.
Ranch economic sustainability hinges on asset value dynamics and ranch profitability.
Ranch economic sustainability metrics include multiyear average positive accrual adjusted net income, rate of return on assets (valued at market value) >1.5%, equity to assets ratio (valued at market value) >50%, and current ratio >2%.
Sustainable foods and sustainable ranching are often discussed. Much of this discussion, and the relative “sustainability” of either products or practices, focuses on environmental or social concerns. However, sustainability of food production systems, and particularly those that involve and include ranching, are undeniably complex (Fig. 1). Without consideration of economic sustainability, the systems will not be able to deliver either social or environmental services. It is important for ranch owners, managers, and affiliates to understand ranching and ranch economic sustainability drivers to manage and improve these systems.
A case for ranch sustainability
Sustainability, defined as the ability to persist, by necessity must be evaluated over time. The United Nations definition1 “meeting the needs of the present without compromising the ability of future generations to meet their own needs” also speaks to the time dimension of sustainability and relates to ranching. The heritage so greatly cherished among multigenerational ranching families is a testimony to persistently meeting the needs of both man and animals across generations.
According to triple bottom line accounting, sustainability is three dimensional, having environmental, social, and economic (planet, people, and profit) components.2 A sustainable production system must integrate and meet targets for all three dimensions.3 Importantly, the United States4 defines sustainable agriculture as an integrated system that (over the long term) will satisfy human food and fiber needs, in the context of enhancing natural resource and environmental quality, make efficient use of nonrenewable resources, and enhance quality of life for operators and society while sustaining the economic viability of operations.
These definitions are useful conceptually and imply that sustainable ranching requires sound stewardship of the natural (soil, water, and plants), animal (both domestic and wild) and human (families, employees, community, consumers) resources entrusted to the steward's care. However, managers require metrics that determine or are correlated with the likelihood of operational persistence to effectively address stakeholder concerns and manage “sustainably.”
Metrics for environmental sustainability are often defined in the context of environmental impact or resource use intensity (i.e., the inverse of efficiency). For ranching systems, effective metrics should be indicators or predictors of future resource integrity or capacity to continue to deliver production, environmental, or ecosystem services. Environmental sustainability metrics for ranching often describe soil health and stability, water management and quality, air quality, greenhouse gas emissions, habitat management, and responsible use of herbicides/pesticides. Grazing animals upcycle forage nutrients into high quality protein and co-products for human use while facilitating nutrient cycling and carbon sequestration. Responsible grazing management contributes to a healthy ecosystem, improves soil health, reduces soil erosion, and enhances water infiltration. As the global population expands, the competition for natural resources and the need to produce more from less will intensify, so sustaining the environment, its resources, and the capacity to produce food from these renewable resources are critical to our future.
Social sustainability metrics are somewhat arbitrarily defined by various organizations and emphasize people and their communities. Ranches and rural communities enjoy a symbiotic relationship, each contributing to and supporting the other. Fair and equitable treatment of family, employees, and neighbors, animal welfare, and traceability (related to food safety, wholesomeness, and quality) are frequent components of this sustainability dimension. Governance issues such as business ethics and involvement in policy development and implementation at the local, state, and national levels are components of social sustainability. Metrics in this dimension should be predictive of the well-being of members of society affected by the activity, both directly and indirectly. They may also be indicators of the maintenance of the “social license to operate,” or the acceptability by the public of the practices employed by the ranch.
In contrast to the environmental and social dimensions, metrics for monitoring economic performance and viability of agriculture production at the firm level are well defined5 but have rarely been explicitly associated with sustainability. The economic sustainability dimension of ranching operations seems to attract less societal/consumer attention or concern than the other two dimensions. The environment potentially affects all members of society, and many have personal concerns about elements often included as indicators for social sustainability. However, when it comes to economic sustainability, seldom does public concern extend beyond the personal boundaries of food price. In some cases, the idea that ranchers would profit from managing natural resources and producing food and fiber is made to seem unpalatable.
A portion of the hesitancy to discretely define ranch economic sustainability metrics stems from there being at least three hierarchical layers to ranch sustainability: 1) continuity of a ranching business (ranch ownership); 2) continuity of use of the ranch property for similar purposes; and 3) sustaining food and fiber production and ecosystem services to meet society's needs. Multigenerational ownership of a ranch has long been equated with sustainability. However, a change from one family ownership to another does not necessarily nullify sustainability of a ranch. Assuming those commencing their ownership continue to use the natural resource in compliance with the previously mentioned USDA definition4 of sustainability, the “ranch” remains sustainable. If primary use of a ranch changes from its use as a platform supporting land-based enterprises, or if its natural resources are mined or eroded, and food and fiber production and wildlife habitat are no longer sustained, then the property is no longer sustainable as a ranch, regardless of ownership. Lastly, profitability of ranch enterprises changes annually, but as long as the sum of ranch enterprise productivity and financial returns are sufficient to meet ownership financial requirements, the ranch can remain sustainable under the current ownership.
Characteristics of an economically viable ranch
Two distinct and separate financial activities exist on a ranch: land ownership and enterprise pursuits (Fig. 2). Land ownership is a passive long-term activity involving an asset that typically appreciates. Ranch enterprise pursuits are active, involve people and assets such as animals and equipment that depreciate, generate revenue, and incur annual expenses. These pursuits include but are not limited to food and fiber production, mineral harvest, energy production, recreation, and agritourism. Economic viability is often enhanced by diversification of enterprises (when possible), optimization of their productivity, and cost management.6 These costs include fixed costs that commonly represent up to two-thirds of total annual ranch expenses. Ranch pursuits produce marketable products and experiences from natural resources, therefore responsible stewardship of resources directly contributes to ranch economic viability and therefore ranch sustainability.
Economic sustainability metrics for beef cow-calf operations9
Metrics for ranch economic sustainability
Numerous resources offer sustainability metrics for the three dimensions as they pertain to beef production7,8 and others suggest system-level metrics.9,10 Examples of production efficiency and financial metrics for cow/calf operations are included (Table 1). Many of these metrics are interrelated and reflect outcomes of management action or decisions. In the context of persistence of a firm, metrics associated with profitability, solvency, and liquidity are standard elements in models predicting business persistence.11,12 The purpose of this viewpoint is to nominate specific metrics for the assessment of economic sustainability of a ranch business. The nominated metrics consider a rolling-annual-average assessment of sustainability as well as the ability to endure potential black swan events. Black swan events are rare and unpredictable events resulting in negative impacts on markets and investments, in turn resulting in severe consequences for firms, sectors, or entire economies.13
Profitability is the primary prerequisite for ranch sustainability. Measuring ranch operational profitability involves accrual adjustments to pair revenue with expense during a fiscal year and includes an annual depreciation expense. Net income is accepted as a direct measure of profit over a defined period, usually a year. The net income metric is calculated from an accrual-adjusted income statement as:
Total operational revenue includes revenues from all ranch enterprises. Total operational expense is the sum of all cash expenses and depreciation and owner labor (if no payroll checks are written to ownership). The net income calculation is a culmination of annual activities including owner/manager compensation. Obviously, numerous other individual enterprise metrics (production, efficiency, and financial) impact net income.
Ranch operations with a positive multiyear average net income can be sustainable, even though some of the years contained in the average may have negative net income. Most ranches do not have to register a positive net income in every year as adjustments to capital asset purchases and contributions from outside capital (money invested from a source remote to the business) would occur. The ranch would continue to have cash flow while profitability would be negative. Yet, at some point, even those capital assets will have to be replaced requiring the ranch to make a positive net income or face liquidation. Furthermore, some individual pursuits making up the ranch operation may not be profitable every year, and other pursuits may register a positive net income. Fixed cost allocation across ranch pursuits influences individual enterprise profitability. Fixed cost allocation is a management decision involving assignment of fixed costs to individual ranch enterprises.Examples of fixed costs include owner labor, property taxes, insurance, depreciation, repairs, and interest.
Rate of return on assets (market basis)
Rate of return on assets (ROA) on a market basis is calculated as:
Net income is defined the same as with the Profitability Matrix, however, the annual interest expense (if any was paid) is added back. This removes the effect of any financing activity from the revenue generation capacity of the asset, thus recognizing ROA as a feature of asset use and not financing decisions. The assessment of long-term sustainability should involve market values of assets. Annual performance evaluation of a single enterprise or management efficiency should use the cost basis of the assets. A market basis ROA of >1.5% is a practical target for ranches. The relatively low ROA of ranching is an indicator that it is a capital-intensive business, which can be a barrier to entry for new participants who lack substantial investable capital, or who require higher rates of return to justify capital investment.
An issue with this metric is the externalities of increased market value of owned assets (primarily real estate). Using the market value compared with cost basis, when the land asset has been held for some time, or during periods or locales of rapid real estate value appreciation, will result in a much lower ROA, yet is representative of the outside demand for ranch real estate. As real estate values rise, ROA will decrease (unless operational efficiency increases causing net income to rise). Owner/ranchers will ultimately have to decide whether the current uses of the owned ranch assets are generating sufficient returns to continue to be invested in ranch real estate.
The rate of return on assets is a viable indicator of sustainability of a ranching operation; as ROA decreases toward (or below) zero, it becomes increasingly likely that the ranch will not persist in its current form. If ROA declines because the numerator (net income) is decreasing, management must react to seek increased income, reduced expenses, or improved efficiencies. Most operators in commodity businesses are price takers with minimal market influence, and therefore inflation in input expense and/or decreases in market price and revenue will require that operators either identify new markets or business models, add additional enterprises, and/or increase efficiency in current enterprises to maintain ROA at acceptable levels. These same drivers affect net income.
When expressed on a market basis, ROA is subject to the externalities of increased demand for ranch real estate, and the valuations generated by this demand are often uncoupled from its production revenue potential. As a result, even a profitable (positive net income) operation may have a diminishing ROA due to factors beyond the control of the operator. In fact, good stewardship of the resources that leads to their improvement over time is likely to also increase the amenity value and desirability of the property relative to others in the agricultural real estate market. While this increase effectively rewards the stewardship by increasing owner equity, it may result in diminished ROA and therefore an incentive to sell the asset and reinvest the capital into a higher returning (or less risky) vehicle.
In both cases (declining net income, “numerator effects”; increasing asset value, “denominator effects”) the result is the same; ROA that decreases toward zero indicates that the operation is less likely to persist in its current state, and its sustainability is threatened. The relationship between ROA and sustainability of the ranching operation holds whether the operator is also the landowner (i.e., is engaged in both the passive real estate activity and the active operational pursuits) or not (i.e., an operator on land leased from another entity). In the latter case, increasing land values will reduce ROA to the landowner unless rents are increased; these increasing rents reduce net income and therefore ROA to the lessee/operator. Again, downward trending ROA threatens the sustainability of the ranch, as either it may be sold, or escalating rental rates relative to revenue force the operator out of business.
Equity to asset ratio (market value)
While any ranch operation must have a positive net income periodically, the balance of owner assets and liabilities indicates how long sustainability may exist. This balance is best illustrated by the equity to asset ratio. This ratio is a measure of the financial leverage of a business, and is an indicator of solvency, or the capacity of the business to meet its debt obligations. The calculation is simply:
With a target of >50%, this ratio represents how much of the business is owned versus that portion owned by financiers. For ranching operations, owner equity is a result of owning real estate, breeding herds, market animals, etc., where the value of those assets are greater than the liabilities owed. Ranches with an equity to asset ratio <50% can have difficulty securing loans to purchase or support noncurrent inventory assets. Three noteworthy points follow. First, as market value of assets increase, the need to borrow money for additional asset purchases increases. Yet ROA at market value is low, making debt service difficult as the excess earning relative to asset value (debt obligation) is low. Second, it is this ratio that has contributed to the sustainability of many ranches. As the real estate value of owned land increases, market-valued equity increases, although net income may be declining. The increase in equity to asset ratio allows cash acquisition through financing for either expansion (to increase gross revenue) or operations financing (to relieve cash flow constraints). Third, this ratio incorporates the need for current assets to pay current liabilities as well as noncurrent assets and possibly more in the case of a black swan event (internal or external). Equity to asset is a measure of resilience—an indicator of business capacity to withstand financial shocks. Current equity capital can be set aside as a risk management tool as in the case for drought management or a sudden drop in cattle prices due to external forces.
The interaction of ROA at market value and equity to asset ratio at market value will influence whether subsequent generations foster ranch sustainability. Specific to cow-calf operations, productivity of the cowherd is maximized relative to the annual precipitation received, yet input costs will continue to rise due to inflation. Furthermore, these operations tend to be price-takers. Consequently, net income from this pursuit is at risk due to a rising cost of production relative to commodity prices that the operator does not control. Couple this with rising market values of the assets and ROA declines over time. How long a ranch operation can operate in this environment is dependent upon the equity to asset ratio. Subsequent generations may choose to exit the operation before driving the equity to asset ratio below acceptable levels.
Disruptive events such as drought, flood, wildfire, market interruptions, and litigation can threaten ranch economic sustainability. It is imperative that a ranch has adequate liquid assets to pay current liability obligations to endure such circumstances; in other words, resilience is an important feature of sustainability. The current ratio indicates the ability to pay short-term liabilities as well as quickly mitigate the impact of these unforeseen events. Current ratio is calculated as:
A goal is to maintain a current ratio >2. Current assets can be cash, savings, investments, insurance, market livestock, or other assets that can be quickly liquidated.
Ultimately, a ranch operation can meet each of these metrics under the current ownership and yet not be sustainable into the future. If sustainability requires persistence across generations, only the coming generation will determine whether it will be sustained. Subsequently, if the ranch is sold, the economic sustainability definition of past ownership has not been met, but the economic sustainability tenure for the new ownership is reset to zero. In either case, the real estate probably remains; thus, the environmental and social sustainability definition has likely (at least partially) been met.
Sustainability of food production systems is often described as sustainability of an “industry.” However, it is the sustainability of the firms within those industries that ultimately impacts the viability of the system capacity to persist into the future. Numerous metrics are available for tracking the production efficiency and financial health of food and fiber production systems, but few have been nominated for measuring economic sustainability at the ranch level. If only one measure must define economic viability, the measure would be a positive multiyear average accrual-based net income. However, we contend the compliment of a positive multiyear average accrual-based net income, a market-based rate of return on assets >1.5%, an equity to asset ratio of >50%, and a current ratio >2 is necessary to measure ranch economic sustainability.