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Midsummer financial checkup keeps your farm on track

By Paul Dietmann, Badgerland Financial

The last thing most farmers want to do in the height of the growing season is to think about their finances. However, there are a few items of general maintenance that you can do this time of year to keep your farm operating at peak financial performance.

Balance Sheet
First, let’s talk about your farm’s balance sheet. The balance sheet is a snapshot of everything you own and everything you owe. We recommend updating your balance sheet every year on January 1. Balance sheets that correspond to the calendar year can be combined with the Schedule F from your federal income tax return to run a whole host of financial performance ratios.

While a January 1 balance sheet is great, there is no reason you can’t update it more often–semi-annually, quarterly, or even monthly. Midsummer is a great time to update your
balance sheet.

There are a couple of good reasons for updating your balance sheet more frequently than once a year. First, the more often you work with your balance sheet, the better you’ll understand it and the more useful it will be to you in managing your farm business. The differences between current, intermediate, and long-term assets and liabilities will become intuitive to you. You’ll be able to calculate your net working capital as quickly as you can figure out yield per acre.

A second reason to bring your balance sheet up to date more frequently is to measure financial progress over time. There are times of the year when it feels like a lot of money is leaving the farm and very little is coming in. It can be very discouraging to work from sunup to sundown and feel like you have nothing to show for it. By updating your balance sheet in mid-summer, you’ll account for the value of growing crops, the inventory of hay you’re building up, and other items that don’t show up in your checking account. You’ll see the fruits of your labor on your balance sheet.

Net Working Capital
Finally, frequent updating of your balance sheet will help you monitor one of the most important indicators of your farm’s financial health: your net working capital position. To calculate net working capital, start with current assets (cash, and anything that will either be converted to cash or used up within a year) and subtract current liabilities (anything due now or coming due within a year).

Current assets and current liabilities can fluctuate a lot over the course of a year. Frequent monitoring of both will help you maintain a strong net working capital position all year long.

A strong net working capital position does two things. First, it will help you withstand an unexpected financial setback such as a major machinery repair bill. Second, it will allow you to take advantage of an unexpected opportunity that presents itself.

What is a strong net working capital position? Your net working capital should be at least equal to 15 percent of your farm’s expected gross income. If you expect your gross farm income to be $100,000 in 2016, your net working capital should be at least $15,000.

It’s important to note that your net working capital doesn’t all have to be held in cash. Current assets include items such as feed and crop inventories, the value of feeder livestock, prepaid expenses, and accounts receivable. However, 10-15 percent of your current assets should be held in cash or items that are near cash such as inventories of crops that you intend to sell. If you have adequate net working capital but you’re a dairy farmer and all of your current assets are held as feed for your cattle, a big unexpected repair bill still has the potential to cause a major financial challenge.

Cash Flow
Moving on from the balance sheet, midsummer is a great time to reassess your farm’s likely cash flow for the year. A month-by-month cash flow projection allows you to predict when cash will flow into the farm business, when it will flow out, and how much you’re likely to have in the farm checking account at the end of each month.

We recommend putting together a cash flow projection at the beginning of each year. This allows you to create a plan for the months when cash flow falls short. Maybe you’ll change enterprises to smooth cash flow or apply for an operating loan to carry your farm through the down months.

A midsummer cash flow assessment helps you use updated information to see if your plans are still on-track for the year. All of the spring bills should already be paid, crops are in the ground, or perhaps you’ve already been harvesting and selling some of your annual production. If expenses were higher than expected or revenue looks like it might be lower than you predicted back in January, there’s still time to adjust your plan for the remainder of the year. You don’t want to get stuck making hard choices about which bills to pay, to let slide, or to put on credit cards.

Midsummer tends to be the time of year when you’re able to identify which pieces of equipment need to be replaced or when you dream about how useful a new building might be. Updating your balance sheet and cash flow projection will help you figure out your capacity to purchase new capital assets such as machinery or buildings. Can you free up enough cash to make a capital purchase without cutting too deeply into your net working capital? Or, do you have enough available cash flow to make loan payments while keeping your cash in reserve?

If you decide to make a capital purchase, sit down with your agriculture lender to review your financials and calculate the appropriate ratios before making the investment.

Credit Report
Now would also be a good time to request a free copy of your credit report and review it for any errors. All three consumer reporting agencies (Equifax, Experian, and TransUnion) are required by law to provide you with a free copy of your report once every 12 months upon your request at www.annualcreditreport.com. This website is the only authorized provider of free credit reports under the law. Don’t be fooled by others promising free reports and then trying to sell you more products.

A midsummer financial checkup should be relatively painless, shouldn’t take too long, and will help you keep your farm running smoothly through the rest of the year.

Paul Dietmann is the Emerging Markets Specialist with Badgerland Financial, a member-owned Farm Credit System institution in southern Wisconsin.

From the July | August 2016 Issue

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