Organic Broadcaster

Value of good recordkeeping shows at tax time

By Andy McCarty

As a farmer, you are faced with a greater number of uncertainties than most business owners. While you have the everyday challenges related to employee management, time utilization, equipment malfunctions, etc., you also face issues out of your control such as government legislation (or lack there of), commodity pricing, input costs and the weather. With all of these uncertainties, monthly bookkeeping and review of your financial position is easy to overlook. This can leave you scrambling to get everything together for your tax preparer this time of year. The result could be a tax return that has very little usable data for you to analyze your financial position to make decisions that impact the financial well-being of your farm. Let’s review the usefulness of well-maintained records and the options you have available to make bookkeeping easier.

Loan Applications

The ability to obtain credit is largely based on your past financial performance and projected ability to repay the debt. Tax returns are often used as the source of past performance information. However, tax returns often do not reflect the true cash flow of the business. Good records that show sources and uses of cash, plus an accurate balance sheet, can be valuable tools for obtaining credit. In addition, good year-to-date records can show current performance and how you’ve made steps to improve your operations, which can help in obtaining new credit that may have been previously denied.

Once you’ve obtained a loan from a financial institution, they will most likely require you to fill out an annual “book value” balance sheet showing your assets and liabilities as of the end of each year. Your records will likely produce a “tax basis” balance sheet. Adjustments for appreciated items and book versus tax depreciation can be easily made to prepare your book value balance sheet. Obviously, for this to be successful, accurate records are a must.

Benchmarking

Have you ever wondered how your farm compares to other similar farms in the area? Comparing financial data and ratios of similar-sized farms is a great way to spot strengths and weaknesses. This assessment can lead to both financial and non-financial improvements on your farm, many of which may make the difference between struggling financially and being successful.

How do you find the financial data of other farms? In many cases, you can find financial ratios on the internet. You can also search for a consultant who specializes in farming and has a client base of comparable farms. Often times these consultants can provide insight into your operations in a way you have never thought about before. Your tax preparer would also be a good source of information, assuming you are using a tax preparer that specializes in the farming industry. Data can vary significantly by region, so look for benchmarks for farms that are in your region and of a similar size with a similar production base for comparison.

The University of Minnesota “FinBin Farm Financial Database” is a great place for organic farmers to find benchmarks. Go to www.finbin.umn.edu and click on “generate a benchmark report.” You can select “Organic” in the “special sorts items to include” and then select other options that fit your farm size and type.

I often see a good example of benchmarking in the dairy industry. Many consultants and others who do benchmarking break down the income statement of the dairy farm using hundredweight as the denominator. Farmers can compare revenues and expenses per hundredweight. For example, if labor costs per hundredweight of their dairy are considerably higher than similar dairies, it can mean higher wages are being paid, or more employees per pound of production than average. Labor is just an example; nearly every item on the income statement can be assessed using benchmarking to compare results with other similar farms in your region.

Benchmarking only works if you are using accurate, up-to-date records to complete your calculations.

Capital Purchases

Many farmers think purchasing equipment at the end of the year helps to reduce their taxes. Though tax savings are attractive, oftentimes this is an emotional decision and the financial result may not be the best outcome for your farm. Facilities expansion and equipment purchase or lease decisions should be made by estimating your return on investment from the purchase. Sometimes this return is financial, as in increased yields or cost savings, and sometimes it is non-financial, such as in time savings. Either way, the result needs to be compared to using the funds toward other purchases, improvements, debt reduction or savings to determine if it truly the best use of funds.

To be able to make accurate return-on-investment calculations, you need to have accurate historical figures to project revenue, cost of inputs and tax cost or savings. Depending on the size of the purchase, it is always a good idea to get your farm accountant involved in the decision making.

Financial Projections

Recognizing upcoming financial difficulties for your farm can alter current decision making. When times are good, it is easy to look at year-end tax estimates and focus on spending as much as possible to eliminate your tax liability. However, spending your money now means putting yourself at risk if times get tough.

Running a projection for your farm by altering your revenues and input costs can give you an idea of how financially stable your farm is. For example, if revenues fall by 20 percent and input costs remain stable or increase, would you be able to pay your operating costs and cover loan payments? How does adjusting for these variables affect your loan covenants? And what does that mean for your interest rate or the rights of your lender to demand payment?

Keeping accurate historical records will give you good data to better project the future. Accurate projections allow you to make adjustments before you are forced into a bad situation. It may even make the difference when it comes to your farm’s survival during a tough economic stretch.

All of the above reasons for accurate records point to one overall theme – risk management. Risk can be an IRS audit, economic downturn, a purchase decision, or violating loan covenants. Having accurate records helps to limit all of them. I hope that by decreasing risk you also experience a decrease in stress. In the end, having up-to-date and accurate records allows you to focus more of your time and energy on your farm.

Andy McCarty is a certified public accountant and tax consultant with Badgerland Financial, a Farm Credit System institution that provides financial products and services for agriculture and rural Wisconsin.

From the January | February 2015 Issue

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