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Side by Side 2017

Know Where You Are To Get Where You Want To Be

Dr. David Kohl, professor emeritus at Virginia Tech, spoke recently to some of our young and beginning producers about financial management strategies that every agricultural operation should practice. One of his assignments to the producers draws on his own practice as a partner in a dairy and creamery, Homestead Creamery.

Farm life, for many, slows down in November and December, giving producers the time they need to focus on good financial management. This would be a good time for you to assess where you stand financially as you wind down one year and start developing projections for the next.

At Homestead Creamery, the Friday after Thanksgiving marks the start of a financial planning process that culminates in a “Groundhog Day Game Plan.” The process looks like this:

Manage And Analyze Your FinancialsUpdate your balance sheet. If you are consistent in how and when you capture your assets and liabilities, it is easy to see your operation’s financial progression from one year to the next. The dairy strives to have an up-to-date balance sheet as of January 1, and then compares the resulting income statement against projections for the year to see how much – and why – the numbers varied. Were the deviations caused by macroeconomics, such as cheaper fuel? Or was it microeconomics at work – perhaps something management did right or wrong?

Develop cash flow projections. Calculate income minus expenses to determine whether your business will cash flow. Take the exercise a step further and use your projections for a baseline from which to develop several what-if scenarios for the coming year. If corn prices were to fall below $3.50 a bushel, could you pay your bills? This exercise allows you to develop a focused plan so you understand what adjustments might need to be made in your operation.

Review and discuss. After the partners in Homestead Creamery finish thinking through their what-ifs, the management team critiques the budget to identify potential holes. Having another set of eyes is critical to stepping back and considering additional possibilities or alternative ways of looking at potential challenges. If you don’t have a management team, turn to your outside experts, such as a lender, to review your projections. Good lenders will offer thoughtful suggestions and ideas to consider.

Commit your goals to writing. This includes business, family and personal goals in one-, three- and five-year increments. Every person involved in running your operation should be asked to complete this exercise. When each person shares his or her goals, it becomes easier to prepare for and make changes in a business.

If you can have your goals articulated, your balance sheet updated and your cash flow planned by Groundhog Day, you will be well-positioned to make sound business decisions and well-prepared for discussions with your lender in 2018.

Preparing Your Game Plan for Cash Rent Negotiations

Two years of declining farm profits and the resulting impact on farmland values is anticipated to influence the upcoming season’s cash rent negotiations. For those entering negotiations in this economic environment, preparation will be key to successful agreements. Dr. David Kohl, professor emeritus at Virginia Tech, recently spoke at our annual Side By Side conference and offered a checklist to help tenants and landlords get organized ahead of negotiations.

  • Have a game plan. Between harvest and the new year, update your balance sheet and start developing a cash flow and breakeven analysis for the next growing season. This is powerful information for tenants because it allows them ask critical questions even before negotiations begin, including: Can I afford to pay cash rent on this land? Tenants who understand their cost of production also are better positioned to have meaningful discussions with their landlords.
  • Pay attention to land practices.  Landlords need to approach their farmland as an annuity, one which needs to be well tended for their future security. It might be tempting to go with the producer who agrees to pay the highest rent. But there can be real value in rewarding a tenant who understands the importance of keeping your grandparents’ farm looking nice. More and more tenants are focused on keeping the rented ground in top condition and keeping landlords informed some now even using drones to give their landlords an overview of what is happening on the land.
  • Set and share your goals.  Separately, tenants and landlords should write their one-, three- and five-year goals. This exercise will allow each side to discuss where goals are similar and where steps might need to be taken to prepare for change. For example, the landlord might be ill and plans to sell the land in the future. This would allow the two sides to discuss whether the tenant could one day buy the land. Or the tenant might plan to take on additional land and bring a daughter or son into the operation.  This could lead to a discussion about how additional operators would affect the landlord-tenant relationship.

Today’s agricultural economy requires a keen focus on costs, including land costs. But Dr. Kohl advises not losing sight of something more enduring than the current down cycle – successful working relationships between landlord and tenant.

“Often,” Dr. Kohl said, “it’s the intangibles that are more important than the financials.”

Creating and Understanding Your Balance Sheet

In a down cycle, many producers focus first on cash flow, seeking places to trim costs and assessing whether income will cover expenses. But it’s important to also pay attention to the farm’s balance sheet because it addresses an operation’s long-term viability.

A balance sheet is quite straight-forward: Current and noncurrent assets are listed on one side, current and noncurrent liabilities on the other side. The difference in the totals is an operation’s equity – a point-in-time snapshot of an operation’s solvency.

Most businesses update their balance sheet at the end of the accounting period, such as the end of the tax year. Some check their numbers quarterly. Lenders will ask to see up-to-date balance sheets to determine an operation’s net worth, as well as to generate a number of ratios that provide insights into your operation’s financial health.

Assets

Let’s look first at the asset side of the balance sheet. Assets are everything owned by a business or individual. Current assets are considered “liquid”—those that are cash or can be turned into cash promptly, including checking and savings accounts or mutual funds, stored production (such as grain in the bin), market livestock and growing crops, feed on hand, paid-for but not yet used inputs or other supplies, and accounts receivable.

Noncurrent assets are those that can’t be readily sold, such as machinery and equipment, vehicles, breeding livestock, co-op stock, farmland, your house, other buildings, or a retirement account that is subject to government withdrawal penalties, etc.

Liabilities

Current liabilities are those that are due right away—usually within the next 12 months. These include accounts payable (such as for inputs, or land rent), farm taxes, current notes and credit lines, accrued interest on operating or term loans, the current portion of principal due in 12 months, credit card debt or loan payments to family members.

Noncurrent liabilities include loans used to purchase assets that have a life-span of more than a year, such as vehicles, machinery, farm ground or a home. They also could include an agreement to buy out a partner or a parent’s share of the business.

Valuation Issues

While the concept of a balance sheet is fairly simple, it is not without gray areas. For instance, how do you value grain in a bin or market livestock? Machinery or equipment? Farmland? Do you use a cost basis or market basis? In some cases, the resulting value can be quite different.

For production of commodities such as grain and livestock, using a market valuation makes sense. The market price might be one that is locked in on a sales contract or a local destination’s delivery price. While the value of unsold inventory changes daily, producers commonly use prices for the date their balance sheet is completed to capture the value of their assets.

Putting a value on vehicles or machinery is more difficult. A piece of machinery that cost $250,000 new will be valued differently at today’s replacement cost or trade-in market value. Depreciation is used by many producers to account for changes in value. Just be sure to depreciate every year to ensure consistency in tracking values and to capture any moves in the market for resale or trade purposes.

The value of farmland and other noncurrent assets also changes over time. Again, consistency is key. If you always carry assets at a cost basis, continue to do so. This will help you avoid any misrepresentation of a balance sheet due to variances to the market over time.

Liabilities are a bit easier: Terms of loans are spelled out and the repayment amount as of a given day, even for credit cards, generally can be accessed online.

An easy check and balance is to match assets to liabilities. Most assets will match up to a liability. For instance, if a growing crop is listed as an asset, check that accounts payable for associated seed, fertilizer and chemical have been included as liabilities.

The Bottom Line

The balance sheet is a tool to identify and determine the strength of your operation or your reserve risk-bearing capacity. If you are consistent in how and when you capture your assets and liabilities, it is easy to see your operation’s financial progression from one year to the next. It also is important to share with your lender your chosen methods for tracking the value of your assets so everyone has a clear understanding of your operation’s financial health.

AgriPoint®, one of the free digital tools available to customers of Frontier Farm Credit, includes a worksheet with current assets and liabilities, followed by noncurrent assets and liabilities. When you click a category, it provides a drop down menu of items that fit the category. You can enter what the item is and the amount. As you progress through the form, it automatically calculates your working capital and net worth. When you are finished, you can save your balance sheet for future use, and a click of a button will turn it into a PDF you can file or email, etc.


Uses of the Balance Sheet

Balance sheets are a great tool to evaluate alternative debt structure options that will assist in managing through difficult times. Whether you are creating a balance sheet for your banker or for your own use, here are some measures of your financial position that your balance sheet will provide:

  • Solvency measures the relationships among assets, liabilities and equity to assess “health” of your operation.
  • Liquidity measures the operation’s ability to meet current financial obligations as they come due without disrupting normal business—the ability to generate cash in the short-term.
  • Trends: As you update your balance sheet from year to year, you can see whether your business is progressing—whether equity is growing or shrinking, and whether you are maintaining adequate liquidity.

AgriPoint® includes an option to create trend reports, which show how your operation has been performing historically. The online tool also can run scenarios on how a purchase – or change in price – would affect various aspects of your operation and bottom line.

How to Decide Right Time for Farmland Purchase

While sales activity continued to slow in the first quarter of 2015, farmland remains in fairly solid demand. Interest rates still are attractive and land in many areas across the corn belt is generally cheaper than a year ago, when prices in several areas hit all-time highs.  Some who are bullish on agriculture long-term consider this a good time to expand their operations for a future in which they foresee more consolidation and greater efficiencies in the industry.

For those weighing a land purchase, the decision starts with a realistic cash flow. Whether times are good or bad, cash flow is key to determining if you can afford to buy farmland. In today’s environment of lower commodity prices, potential buyers need to ask: How much room do I have to take on land that is unlikely to cash flow in the current grain cycle? At today’s grain and input prices, borrowers likely will need the rest of their operation to subsidize the land purchase.

The balance sheet is the next factor. Producers who plan to put cash into a land purchase – and many of today’s buyers are doing just that – need to take a hard look at what this does to working capital. Does the remaining working capital provide enough cushion if cash-flow problems develop?

Finally, potential buyers will want to consider their balance sheet equity. A producer might have low enough costs to make land bought at today’s prices cash flow. But if cash flow is tight and working capital is weak, the risk could prove too great. Ask yourself: If I leverage up my balance sheet and I have a bad year, will I still be able to get financing to keep my operation going? Will I be able to invest in a new tractor if my current one breaks down?