FEATURES
Look Back to See Ahead
by Marcia Passos Duffy
Review last year’s numbers for this year’s success
After your tax returns are filed, it is often easy to put behind what happened financially the year before. After all, you are in the midst of a new season, and, frankly, you want to look ahead. However, taking stock of how your farm business fared financially in 2008, and comparing these numbers to what happened in past, can be the most important thing you can do to ensure a more successful 2009. Before you plunge headlong into this season’s plans, take stock of what happened last year. To do that, you have to take a hard look at the numbers.
Do you go with the numbers or your gut?
Farmers—and most business people for that matter—vary in how comfortable they are in getting cozy with their financial data. Some just look at their bank accounts or trust their gut feelings to determine if they are doing OK or not. To be successful today, farmers need to look at some hard data and more sophisticated analysis to back up their hunches.
“Farmers who do conduct an annual financial analysis are anxious to understand the impact that their management decisions had on their balance sheet,” said Jim Marzolf, an agribusiness consultant with the accounting firm Larson Allen LLP (www.larsonallen.com ), a national CPA firm that offers specialized services for the agricultural industry. Marzolf said that producers who are comfortable with financial analyses want to use their historical data to guide future business decisions for their farm.
On the other hand, Marzolf said, farmers who do not conduct financial analyses are “ … typically making decisions based on instinct and gut feelings.” For these farmers, analyzing the numbers is sometimes thought not to be worth the time and money, he said.
Not analyzing the numbers in this day and age can be a serious mistake, said Jeff Brandenburg, a partner with Clifton Gunderson LLP (www.cliftoncpa.com), certified public accountants and consultants that specialize in agricultural clients throughout the country.
“Farmers that do not plan commonly make wrong decisions on when to replace equipment, they expand and downsize at the wrong times, and find themselves in high tax brackets some years and wasted non-use of low brackets in other years,” said Brandenburg.
In this era of high input costs and low commodity prices, mistakes like these are harder to bounce back from than in the past.
The most important data
While every farm is different, there are several basic types of data analysis that are most important to understand in order to run a successful farm:
1. Year-to-Year Analysis
It is important you conduct a year-to-year analysis, reviewing sales results, average sale per customer/client, and sales by department (if you have different departments on your farm such as agri-tourism admission fees, farmstand sales, gift shops, etc.). As your cost and prices go up, so should the average sale per customer. A year-to-year analysis is also important in order for you not to get false readings on how you are doing financially. A majority of farmers work on a cash basis, so it is important to account for carryover of crops or inventory on hand, crop receivables, prepaids, inventory of supplies, and accounts payable, or they will get false readings on how they are doing financially, said Brandenburg.
2. Cost of production
You need to know the exact costs of production so that you can determine when to buy and sell products. “[Farmers] cannot make good business decisions if they do not know their cost of production,” said Brandenburg. This data is also helpful when you want to compare how you are doing with peers in your industry or region. You can also use your cost of production data to benchmark against your own results of operations in previous years to determine areas where you can improve or any changes that have happened in your farm over the years.
Most farmers focus narrowly on cost control, but it is difficult to evaluate financial performance if we don’t divide total costs and revenues by the number of units produced or sold to determine an average selling price per unit, added Matzolf. “Producers sell commodities by the bushel or pound and need to reference their performance on that basis.”
3. Financial Ratios
These ratios measure business liquidity, solvency, repayment capacity and efficiencies. Agricultural lenders are also interested in this information and will ask their farm customers to perform the analysis and identify these ratios. “The most important financial measure for Farm A may not be the same for Farm B,” noted Marzolf. He said that factors that determine which ratios are most important include levels of debt, farm productivity, production costs and family living costs.
4. Return on Investment
The last important analysis is your return on investment for your equipment purchases or farm expansions. This is critical in this credit-crunch era when lenders are looking cautiously at the cost versus benefit of the purchase; you can bet lenders will challenge you to prove the acquisition will pay for itself over a reasonable amount of time.
Red flags—when to worry
While number crunching and analysis (preferably with your accountant or financial planner) may help you sleep better at night, there are some red flags that should give you reason to pause.
Cause for worry in any business can be poor cash flow, excessive expenses and poor tax planning to take advantage of the current tax laws (which are ever-changing).
Unlike most businesses, agriculture producers have additional worries of environmental risks, such as the weather, animal health and diseases, not to mention the ever-present gyrations in the cost of fertilizer, feed and what you get for your product at market.
“It is important to include the years impacted by [these] risks in a trend analysis,” advised Marzolf. “It is important to appropriately factor these risks into the planning process.”
How to get a good handle on your financial data
For starters, producers need to have an accounting system that accurately tracks their revenues and expenses. The best thing to start is to use what you may already have: reports from your accounting software, Excel spreadsheets, or, if you or your accountant or financial planner has it, more sophisticated financial analysis software that can create trend analysis based on multiple years of operation. Without tracking the numbers, it is impossible to get a good handle on your financial trends.
“You can’t manage what you can’t measure,” said Marzolf.
Other things you should do:
1. Set attainable goals and/or budgets for your business.
2. Keep up with current trends of the global economy through your farm associations.
3. Use the Internet to do your own research on financial numbers by industry. Use these numbers and tools to your advantage to compare how you are stacking up compared to your peers.
4. Use a consistent analysis from year to year. Without comparing apples to apples, you may not be getting the right reading on trends on your farm.
5. Use financial ratios (with the help of your accountant if necessary) to do a diagnosis of the financial strengths and weaknesses of your farm.
6. Be sure to do tax planning annually and well in advance since tax laws are changing often.
7. Review your financial analysis with a trusted advisor to get feedback for improvement. You should also meet with a professional accountant more once a year at tax time. “Farmers should meet at a minimum of two to four times a year with a professional accountant to get outside opinions and advice,” said Brandenburg.
The author is a freelance writer from Keene, N.H., and longtime contributor to Farming.
