I recently had a series of meetings that required quite a bit of driving and with that, windshield time to think.
A lot of the work I do with farm families involves financial analysis, so I think about that a lot. I came to a very basic question. Why do farmers keep financial records? Even broader, why do they keep any records?
From a financial perspective, I think there would be quite a variety of answers, ranging from “because we have to” all the way to “because we want to understand.”
Certainly, there is an application of the “because we have to” aspect, given reporting requirements to Canada Revenue Agency and lenders, for example. I am going to explore the “because we want to understand” segment.
This would be the preferred answer from a business performance perspective. It isn’t possible to know how the business is really doing without looking at records. That’s obvious. Without records, knowing how the business is performing is a function of gut feel — not the best approach. It’s perhaps of less consequence when margins are wide and cashflow is strong, but much more of concern in the current financial environment. Fortunately, interest rates are very low, but that’s a whole other discussion.
Assuming a farmer would want to use a base of information (records) to gauge performance — the “because we want to understand” space — the question then becomes “how are the records being captured.” This is such a fundamental question, and by my observation, one that has not been critically examined by the majority of farm businesses for a long time. As I think about, it makes sense. Why would they?
I think it is fair to say that farming as a business has changed and will continue to change. Logically, this would suggest that it is more important than ever to be capturing financial information in a way that provides a farmer with information she or he can use to support management and investment decisions.
And thus, my question. When was the last time you examined how you record the financial information you collect? When was the last time you reviewed the chart of accounts in your financial bookkeeping software program?
Like most farmers, you likely have multiple enterprises within your farm and although you work each day within those enterprises, you may not have given a lot of thought to enterprise analysis. A form of financial analysis — enterprise analysis — looks at a business in terms of each individual entity (enterprise) within your farm business so you can determine where best to allocate your time and money.
The enterprise breakdown can be broad, such as a mixed farm with its operations separated into grain and livestock enterprises, or more detailed such as a grain farm with each crop as an enterprise — or both. The business can be separated into as few or as many enterprises as you wish, depending on your preference. The analysis can and should be applied to past years and future years in projected performance.
You can use enterprise analysis for various purposes. Time and capital on a farm are constraining resources and as such you need to make decisions where to best allocate those resources. Different enterprises will report differing contributions to profit. The analysis will help you determine if you allocate more time and capital to the enterprises that are contributing the greatest profit to the overall business or to improving the contribution of a poorly performing enterprise.
A related and more detailed management activity is examining costs of production for each enterprise involved in the business. Costs of production are often categorized as per acre or per animal. This is good and necessary information to have because it helps farmers understand what’s working well and where improvements could be made. Costs saved equate to profit earned.
More detail in the cost of production analysis provides a better base of information from which to understand how financially efficient a farm is. The additional detail I’m referring to includes analyzing costs of production by margins over categories of expenses.
Keep relevant records
The benefit associated with enterprise analysis and margin-based costs of production analysis is directly related to the financial records being used to begin with. Is your financial bookkeeping system structured to give you the information you are trying to capture and analyze?
We refer to the collection and recording of financial information in bookkeeping programs as system design. It’s self-designing, as in working to ensure a farmer’s bookkeeping system is designed to provide the information needed. The work can be done by anyone but would typically benefit by having someone who has experience with bookkeeping and financial analysis. The goal is simple. Re-organize or streamline how information is being recorded so it can be used as effectively as possible. This application falls in the “because we want to understand” segment.
Terry Betker, PAg, is a farm management consultant based in Winnipeg. He can be reached at 204-782-8200 or firstname.lastname@example.org