6 tips for better farm financial management
When running a farm business, it’s important to have foresight. If you don’t plan for the future, you are not going to end up where you want to be.
We regularly see cases where people are thinking about expansion or even just purchasing a new piece of machinery and they don’t do any real planning. In some cases, farmers become engaged in expansion for the sake of expansion without taking the time to understand how their business will be affected. They should be taking out their pen, paper and calculator to note the added costs and the potential for added revenue, so the impacts of expansion don’t take them by surprise. Some farmers also make the mistake of spending too much time on expansion plans without talking to their banker. If the banker doesn’t lend them the money they need, it is unlikely these plans will proceed.
Keeping in mind the importance of vigilance, planning and communication, here are six ways to prepare for the future of your farm business.
1. Maintain your bookkeeping
We still see clients who take the “shoebox approach” to bookkeeping: they bring in all of their records at the end of the year. If that’s the way you’re treating your financial records, you need to be more proactive about planning and staying on top of trends throughout the year. Keeping up with bookkeeping allows you to monitor trends. For example, feed costs may be steadily rising, but if you only do your bookkeeping once a year, you’re not going to recognize this trend. Regular bookkeeping can enable you to notice when these costs are starting to skyrocket. That will help you pinpoint the problem and adjust your feeding program (if necessary), thus saving your business a great deal of money.
2. Keep records on an accrual basis
If possible, farmers should keep records on an accrual basis – as opposed to the cash method – as this will provide them with more meaningful and accurate information. In the cash method, you keep track of cash as it is paid and received, whereas the accrual method factors in when you earn the income. Say you’ve sold 1,000 tonnes of corn, but you haven’t received the cash from the elevator yet. On the payable side, maybe you just had a combine repaired, but you still have to pay for those repairs. The accrual method factors in when you earn your revenue and when you incur your expenses, not just when you receive cash or pay for expenses. Using this method will drastically improve the accuracy of your numbers.
3. Keep digital records
We still see many producers (primarily the older generation) who use manual account books. If producers are looking to update their records, there are a number of software products available. Some of these even have modules that help keep track of inventory as you harvest commodities or as livestock is born. If you are fairly computer-savvy, this software is quite user-friendly. However, if you haven’t had any experience with this sort of program, you can get the training you need from any Collins Barrow office with an agricultural specialty.
4. Understand your financial statements
It is important to take the time to understand your financial statements. You should always be looking for year-over-year trends and make sure you know what your bankers are looking for in your financial statements. You may have certain ratios you need to meet and, depending on your debt level, those might even be in your credit facility agreement. There might be a covenant, meaning if you don’t hit a certain ratio, your debt could be called. In practice, this very rarely happens, but lots of larger farms with high debt loads have certain covenants they need to meet. It’s important to watch those.
5. Consider how major purchases affect key ratios
If you are looking at any sort of expansion or a major equipment purchase, you need to consider what impact that will have on your key ratios. Say you have a debt service coverage ratio, which measures the farm’s ability to pay debts. If you’re purchasing a new combine for $600,000 or $700,000, but you finance it over a very short period of time (maybe the rates were better then or that’s what the dealership offered), that could spike your debt payments over the next few years, having a negative impact on that covenant. You should always be aware of the ways that operational changes impact your financial statements.
6. Always maintain open communication
If you are considering expansion and you have a high debt load, your bankers should be your first call. Before investing in expansion, you need to determine if you have room in your credit facility and how it affects your security requirements. Being in frequent contact with your financial advisors is also a wise idea. If you are contemplating a major expansion, your banker may want to see projections from your accounting professionals. The sooner your accountant knows about your expansion plans, the sooner they can give your banker the details they need, accelerating the process and ensuring that all the necessary steps have been taken.
Luther VanGilst, CPA, CA, is a tax manager at Collins Barrow WCM LLP. His areas of experience include audit and accounting, entrepreneurial services, tax advisory and succession planning.
Luther VanGilst
How good records benefit your farm
Luther VanGilst