I recently had the opportunity to lead a two-day workshop on farm financial management.
Near the end of the second day, one of the families asked me if I could provide a process that they could follow on an ongoing basis.
The family wanted to become better skilled at understanding and applying financial management in their decision-making processes. They wanted something that they could use that would help them after they left the workshop.
It was a good question. We were just about finished an in-depth review, discussion and application of basic financial analysis and they were thinking forward to the “next day,” when they would be back on the farm with a 101 things to do.
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Financial ratios are like the pieces of a jigsaw puzzle. Every piece (ratio) tells us a little about the farm’s financial story. It’s important that they be analyzed collectively because some ratios can be counterintuitive.
Ratios can be grouped to provide a bit more information on a farm’s performance, which I liken to reading three or four chapters of a book as opposed to reading the entire story.
It’s a bit challenging to teach financial management in a workshop setting because there is a base of analysis (ratios and indicators) that should be included in the instruction. You really need the “entire story,” or all of the ratios.
Actually, there can be a certain element of danger, or financial risk, in making significant management decisions with only a limited amount of information provided by an in-complete set of ratios.
I think what happens in financial management workshops is that farmers in the audience start to gain a better understanding of the principles and perhaps even begin to see how they can apply the information to their businesses. What they need, and in fact what all of us need is practice.
This is usually where the ball is dropped. Farmers leave the workshops with good intentions but get busy with other priorities and pretty soon what made sense in the workshop is forgotten.
Here is a 10-step process that can be used to help advance your understanding and application of financial management:
- Take a workshop on financial management to get started and then take a refresher when you feel it’s necessary to brush up on your skill set.
- A good base of financial information is required.
If you’re not incorporated, you will need to produce a balance sheet and income statement.
Record assets and liabilities at the same date each year.
Convert your cash income and expense statement used for in-come tax purposes to an accrued statement. Set up a spreadsheet and use it each year to make the adjustments so that you have an accrued income statement.
If you don’t know how to make the conversion, get someone to help. It is extremely important.
If your farm is incorporated, the corporate financial statements fit the bill. However, you will likely need to re-organize the income statement so that you can better understand how efficient your business is at using its inputs, both variable and fixed.
- Find a resource that you can use to provide a complete set of ratios. Accountants, consultants and government websites are good sources. We use 19 business ratios in the work we do with farm families.
- Make sure the resource you use is able to supply you with definitions and calculations so you can refer to them when necessary. That is, when you need a refresher.
- Use a spread sheet to set up the ratios so they calculate automatically.
- Calculate the ratios every year, which provides trend lines. Are things getting better, staying the same or getting worse? It’s easier to try to correct a problem before it gets out of control.
- Create graphs that visibly illustrate the historic trend lines.
- Set targets or parameters of performance and then test your performance against these values.
- Make sure that you have benchmarks so you can compare your results against something other than your own farm’s performance.
- Review the information with a third party to receive an unbiased opinion on your financial picture.
