Running a farm isn’t just what you do in the fields. A farmer also needs to have a solid, up-to-date understanding of their farm’s financial situation, and their financial statements are a powerful tool at their disposal.
No matter if you run your farm as a sole proprietorship or if your farm is incorporated, you should be able to produce the following financial statements to capture a picture of your operations:
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- Balance sheet — Shows what you own (assets) and what you owe (liabilities) at a specific point in time.
- Income statement — Traces of your revenue and expenses over your fiscal year, indicating whether your farm has made a profit or loss.
- Cash flow statement — Details of how cash moves within your farm into areas such as working capital, equipment and debt.
Understanding your financial statements isn’t just an accounting exercise; it’s essential for effective farm management.
Lenders rely on these statements to assess your eligibility for financing, so knowing what they look for can help you plan future operations.
Regularly reviewing your income statement also allows you to identify trends and respond proactively. For instance, are input costs rising faster than crop prices, or have your sales changed significantly year over year?
As well, financial statements are a key component to valuing your farm, which is critical if you are considering transferring the operation or passing it on to the next generation.
Beyond understanding the statements themselves, there are a few key metrics that every farmer should know:
- Current ratio — This is a measure of your ability to pay your upcoming bills and is calculated by dividing your short-term assets by your short-term liabilities. If the number is below 1.0, banks may be concerned about your ability to pay your debts, and it provides a strong indication to a farmer that they need to focus on building cash reserves.
- Debt-to-assets ratio — This is a measure of how much of your farm’s assets are funded by debt rather than equity and is calculated by dividing total liabilities by total assets. A ratio above 0.5 could indicate increased financial risk because a farm reliant on debt is more susceptible to distress in an economic downturn.
- Return-on-assets ratio — This is a measure of how efficiently your farm uses its assets to generate income and is calculated by dividing your net income generated for the year by the total assets your farm owns. Farm operations should aim for a higher number because it indicates that you are getting more income from the resources you have.
- Debt service coverage ratio —This is a measure of how well a company is able to pay the debt it owes and is calculated by dividing your net cash income from operations by your total debt payments (principal and interest) for the year. A ratio typically of 1.25 is ideal because it shows lenders that you have ample cash to pay off loan payments (a ratio under 1 would be bad and should raise concerns).
To ensure the financial success of your farm, review the financial statements received after year-end and compute some of the above financial ratios.
Compare these numbers to previous years to identify trends in your statements so that you can use this information to make informed decisions in the future.
Remember, these ratios are not just numbers; they are the key to making better decisions for your farm, securing financing, and keeping your farm strong for the next generation.
If you have any questions about your financial ratios or need further clarification, don’t hesitate to contact your trusted adviser for guidance.
Colin Miller is a chartered accountant and partner with KPMG’s tax practice in Lethbridge. Contact: colinmiller@kpmg.ca. He would like to thank Yvonne Leineke and Ethan Hunt of KPMG for their assistance with writing this article.
