There are two times when farmers should pay attention to their business’s financial management — when they have a gazillion dollars in the bank and when they have no money in the bank. In other words, all the time.
I’ll start with a generalization and a caveat.
First, the generalization — my observations over time are that farmers’ attention to, and expertise in, financial management have not kept pace with growth and changes in the industry.
Second, the caveat — eight or nine months from now we could be in much different space. Farmers could have experienced a season with much more beneficial weather patterns and one or two major production areas in other parts of the world might have experienced significantly poor crops, helping to bump up commodity prices.
However, as to my opening comment, it doesn’t really matter what the season brings. It’s time to pay attention to financial management. The investment is too great (and continues to rise), profit margins are too narrow, farms are too complex and the rate of change is too great to not focus more attention on financial management.
There are too many farmers who would say, if being totally honest, that they don’t know how well their business is doing financially. There are too many who make decisions about financial investment and take on additional debt on the hope that things will work out over time. Hope is not a good foundation for strategy. Decisions should be made knowing where things are at financially.
Financial management can be a very broad topic. I’m going to focus my comments here on balance sheets. The assets on a balance sheet are what you own. Liabilities are what you owe. Retained earnings, or equity — the difference — is what’s yours. Assets on a balance sheet are recorded at original cost.
A balance sheet is a snap shot in time. It represents a farm’s financial position at the date of completion which is typically once a year. The year-over-year change — increase or decrease in retained earnings — is primarily a function of earnings for the year. This is earned financial progress.
Year-over-year change in equity (somewhat different than retained earnings) is a function of earnings and increases in the value of assets, such as land and quota. Farmers especially need to know how much of their financial progress comes from earnings. This is extremely important. The only sustainable source of cash is profit.
A further drill down into analyzing balance sheets is to look at the liabilities or debt in the business. I think you can analyze liabilities as being “desirable” and “less desirable” debt. Desirable debt to me is “purposed or productive” debt. This is debt that is directly associated with investment that is designed to add profit to the business. Less desirable debt will include over-capitalization, personal-related assets like houses or recreation properties and multiple re-structures to cover past losses. Notice the “multiple” word. Restructuring can be desirable if it is used strategically once in a while, and not on a semi-regular basis.
Of course, this whole discussion on categorizing the debt in your business is subjective. The major benefit here from critically examining the debt in your business is less about how you would categorize a certain liability and more about simply taking another view of your balance sheet.
It seems to me that a farm that has more less-desirable debt would have higher financial risk and that this should be factored into analysis and decision-making processes.
This is only one small part of financial management. If you don’t know how your farm is doing financially, find someone to help you. At the least, it will give you peace of mind. It could reinforce that things are fine. And then again, it could identify a problem area that requires attention.
I often will talk to farmers who are quite capable of analyzing their farm’s financial performance on their own but like to get a second opinion.
Whatever your situation, you need to pay attention. There’s a saying that cash is king. When it comes to financial management, it could be argued that information is king.
Terry Betker, P.Ag, is a farm management consultant based in Winnipeg. He can be reached at 204-782-8200 or firstname.lastname@example.org.