Analyze your farm financials (Credit Corner)
(Editor’s note: Wayne Richard is a regional lending manager with MidAtlantic Farm Credit.)
As a young or new farmer, understanding the financial portion of your agribusiness is a solid starting point to developing your farm’s future.
We’ve narrowed it down to two main sections that can help you better comprehend your farm financials.
Before you look into each of the statements and ratios, it’s important to know why keeping track of your farm finances is important.
It’s not just an item to check off the list – understanding your farm’s financials are crucial to making sure your operation is efficient and profitable, remaining compliant with legal requirements for taxes and payroll purposes, and understanding your financial position for when you need a loan to grow.
A farm income statement is one of three important financial statements used for reporting a farm’s financial performance over a specific period of time. This statement focuses on four key items: revenue, expenses, gains, and losses.
A cash flow statement is a listing of cash (or cash equivalents) entering and leaving an operation that occurred during the past accounting period.
A cash flow budget is a projection of future flows that would include expected payments or payments to accounts receivable. Think of this as a “check book registry”.
As lenders, we commonly utilize a farmer’s balance sheet for a financial reference. A balance sheet is a “snapshot” of a farmer’s financial position and outlines an individual’s net worth.
Net worth reflects the value or dollar amount of the reported assets you actually own, versus how much is currently financed.
Balance sheets from Dec. 31 are the most useful and coincide with taxes. Even if you aren’t requesting a loan, it’s a good idea to gauge your growth and financial position at a given point throughout the year and to keep this timing consistent from year to year.
This should help you to determine both your personal and business financial position.
Financial Ratios and Benchmarks
Financial ratios will tell you how one particular aspect of your operation relates to another in the form of assets and liabilities. You can use these ratios to compare yourself to industry specific benchmarks to measure your performance against the competition and other industry producers.
Assets are what you own. Some examples of assets are cash, real estate, equipment, etc.
Liabilities are what you owe.
Some examples of liabilities are credit card debt, mortgages, equipment, auto loans, etc.
Your current assets are typically balance sheet items that are reasonably expected to be converted to cash within one year in the normal course of your farm business.
These are typically feed, seed, crops held for resale, market livestock and accounts receivable.
Your current liabilities are farm debts that are due within one year.
These are expenses such as cash rent, credit card debt, and accounts payable for seed, feed or fertilizer. Ideally as an owner/operator you aim to have a minimum of a 1:1 ratio.
This means that you have enough cash available to pay all of your expenses and bills for the reported period or year.
This ratio allows you to see that you have $X available to service every $1 of debt.
Working capital is the money available to fund a business’ day-to-day operations.
Positive working capital indicates the business can pay off its short-term liabilities almost immediately.
For your operation, this might look like $ per acre or $ per cow.
Both the current ratio and working capital ratio are measures of liquidity.
Liquidity is the ability of the business to meet financial obligations as they come due.
It is defined as the availability of cash or near-cash assets to cover short-term obligations without disrupting normal business operations.
A good ratio to calculate to reflect liquidity is working capital as a percentage of annual expenses.
Your equity position depicts the relationship between your assets (what you own) and your financial obligation (what you owe).
The equity ratio helps you to evaluate the percentage you own of the assets reported on your balance sheet, versus how much of it may be financed by a lender.
Equity is important because it can help a business owner decide whether or not their assets are making money.
Do you currently own assets, equipment, vehicles, or livestock that aren’t making you any money?
If so, what you own these assets and is there an opportunity to put your business in a better position by using those assets in another way to potentially liquidating them?
While farming is a risky business, identifying production and financial projections are an important management skill.
Think about it this way: What amounts should I invest in acreage to be farmed or livestock to be purchased, raised or sold?
Or, what amounts will I receive for the sale of farm products? Remember these are projections, so do your best to make them realistic.
We encourage meeting with your loan officer to help walk you through this conversation and to help interpret what the ratios and benchmarks mean to your individual operation.
As an owner-operator, it is important to keep accurate financial and production records for your operation.
This will enable you to calculate these projections for the future. If you need some help understanding your financials and taking the next step, give us a call at 888-339-3334.
To read a more detailed blog post on this topic, and to download some statement templates mentioned above, visit mafc.com/blog/analyzing-farm-financial-statements.