Is your operation prepared for tighter margins ahead? You likely complete annual maintenance on your equipment or routine vet checks for your livestock; do you complete a ﬁnancial checkup for your operation? With changing prices and margins from year-to-year, a closer look at your ﬁnancial position may be important for long-term ﬁnancial stability.
Prepare ﬁnancial documents
Financial documents are often completed at year end for accounting, lending or tax purposes. An operation should complete a balance sheet, income statement and cash ﬂow to determine its ﬁnancial position. A balance sheet is typically completed for lending requirements at year-end, but a completed income statement and cash ﬂow may or may not be completed for the operation.
Although a Schedule F may be completed for tax returns, additional steps need to be taken to complete an income statement. Most farms only complete ﬁnancial statements on a cash basis; to get an accurate picture of the operation’s ﬁnancial success in the current year, an accrual adjusted income statement should be completed. Research has shown that accrual basis statements can reveal an operation under ﬁnancial stress sooner than when using cash basis statements.
A cash ﬂow statement is a budget or estimate of all cash receipts or expenditures that are expected to occur during a speciﬁed time period. This statement can be done on a monthly, bi-monthly, or quarterly basis. A completed cash ﬂow will give an operator insight into if the operation can meet all cash needs or when the operation will need operating funds due to cash deﬁcits. In the coming year with the forecast of tighter margins, a cash ﬂow statement will become more important to determine the ﬁnancial strength of an operation and its ability to meet ﬁnancial obligations.
In addition to a complete set of ﬁnancial statements, additional analysis should be completed to determine the ﬁnancial health of an operation. The Farm Financial Standards Council (www.ffsc.org) identiﬁed 21 ratios that adequately measure the ﬁnancial position and performance of an operation. Financial ratios are broken down into ﬁve categories: liquidity, solvency, proﬁtability, ﬁnancial efﬁciency and repayment capacity. Lenders often identify a few ratios they focus on to measure the ﬁnancial position of an operation. Additionally, each operation should identify ratios that help to manage its ﬁnancial stability from year to year.
Analyze key data
When key ratios for an operation are selected, it is then important to identify the corresponding benchmark measures based on demographic location, operation type or size. Financial ratio information and benchmark measures for Iowa farms can be taken from AgDM Information File C3-55, Financial Performance Measures for Iowa Farms. The publication reports farm ﬁnancial measures for all farms by operation type and proﬁt level; data is gathered from the Iowa Farm Business Association.
Production agriculture today is extremely volatile; sensitivity analysis should also be completed to evaluate the ﬁnancial stability of the operation. Examples of changes to measure sensitivity are an increase in expenses, decrease in revenue or increase in interest rates. To measure sensitivity, one should shock revenue or expenses by 5 or 10 percent and interest by 3 or 6 percent. Net farm income is then evaluated to see where the farm’s proﬁt level is after each change. More detailed analysis can include speciﬁcally shocking or changing commodity prices or input prices to evaluate the impact of speciﬁc factors. Can your operation sustain a decrease in revenue due to changes in prices or yields and to what degree?
With proper ﬁnancial analysis and planning, one can prepare an operation to be ﬁnancially stable and successful for years to come. Additional information on ﬁnancial statements and analysis is located on the Ag Decision Maker website.