By Alan Miller

Let’s consider one windshield metric that I first learned to appreciate in the early years of the farm financial crisis of the 1980s. That financial measure is capital debt repayment margin (CDRM). This windshield metric can help provide direction where the farm balance sheet still looks great, but net incomes are likely to drop. For example, should you go ahead and restructure existing farm liabilities now in anticipation of tighter finances ahead? But, is it right for your farm?

If forecasted CDRM is a negative amount, loan restructuring will typically be easier to accomplish now rather than later. The larger the shortfall, or the longer it appears to you it might last, the more incentive you have to adjust now. The 1980s proved how quickly financial reserves reported on today’s balance sheet can erode if asset values soften, interest rates rise, or other financial adversity strikes.

CDRM forecasted for next year compares the sources of income expected to be available for repayment with the demands for repayment. These demands not only include interest and principal due on term debts, but also family living needs and planned expenditures to maintain farm capital assets.

In the 1980s even farms that started with little or no debt could end up having capital debt repayment problems because of these additional demands on repayment capacity. Estimating accrual-adjusted net farm income from operations for the year ahead is the starting point for computing CDRM.

The rest of my story is that I first started forecasting CDRM because a farm lending organization started requiring it in the early 1980s. I don’t remember it being a particularly popular requirement with my farm clientele, initially. However, those forward-looking estimates of CDRM really served the farmers well as the financial crisis of the 1980s deepened.

Could analyzing forecasted CDRM help you avoid disaster in today’s ag environment?

Alan Miller retired recently from Purdue University after serving 36 years as an Extension Specialist in Farm Business Management in Kentucky, Alabama, and Indiana. He has been a Certified Public Accountant since 1991. At Purdue he taught an undergraduate course for agriculture students titled “Accounting for Farm Business Planning.”

By Alan Miller

Future accounting information is inherently valuable for decision-making because it is so relevant to the decisions we need to make now. Forecasted, projected, budgeted, or whatever you want to call it, future accounting information is never more valuable than when the economics of farming are in transition.

Any metric for measuring financial performance or financial condition can be forecasted. Forecasted financial statements are used in many situations to provide insights about what is most likely to happen to a business in the near future. I like to think of forecasted metrics as windshield metrics because they are forward-looking.

With historic or past financial metrics we are looking in the rear view mirror, so to speak, to assess trends in business performance over time and to figure how we got to where we are now. Windshield metrics add a whole new dimension to our management. They provide insight on what direction the farm business is headed and how we should manage in response. Windshield metrics should reflect farm managers’ expectations about what is most likely to happen during the year to come. Occasionally, forecasted financial statements and metrics are prepared for more than one year into the future. This is often recommended when a major change in a farm operation is being considered.

Forecasted income statements need to be accrual-adjusted to produce useful information, just like the ones for previous years. The easiest time to prepare a forecasted income statement for next year is usually right after the income statement for the previous year is completed. Remember to think about using windshield metrics as you plan for next year. In my next blog I will describe one of my favorite windshield metrics for periods of economic belt-tightening on farms.

Future accounting information is inherently valuable for decision-making because it is so relevant to the decisions we need to make now. Forecasted, projected, budgeted, or whatever you want to call it, future accounting information is never more valuable than when the economics of farming are in transition.

Any metric for measuring financial performance or financial condition can be forecasted. Forecasted financial statements are used in many situations to provide insights about what is most likely to happen to a business in the near future. I like to think of forecasted metrics as windshield metrics because they are forward-looking.

With historic or past financial metrics we are looking in the rear view mirror, so to speak, to assess trends in business performance over time and to figure how we got to where we are now. Windshield metrics add a whole new dimension to our management. They provide insight on what direction the farm business is headed and how we should manage in response. Windshield metrics should reflect farm managers’ expectations about what is most likely to happen during the year to come. Occasionally, forecasted financial statements and metrics are prepared for more than one year into the future. This is often recommended when a major change in a farm operation is being considered.

Forecasted income statements need to be accrual-adjusted to produce useful information, just like the ones for previous years. The easiest time to prepare a forecasted income statement for next year is usually right after the income statement for the previous year is completed. Remember to think about using windshield metrics as you plan for next year. In my next blog I will describe one of my favorite windshield metrics for periods of economic belt-tightening on farms.\

Alan Miller retired recently from Purdue University after serving 36 years as an Extension Specialist in Farm Business Management in Kentucky, Alabama, and Indiana. He has been a Certified Public Accountant since 1991. At Purdue he taught an undergraduate course for agriculture students titled “Accounting for Farm Business Planning.”

By Scotty Elston

It is inevitable as a producer you will be faced with adversity, whether weather-related events, volatile markets, labor issues, regulatory burdens, or perhaps farm policy shifts. If you are faced with a substantial financial loss in your farming or ranching operation, what should you do when it comes to communicating this to your lender? Here are a few suggestions that, if followed, will empower and position you to have greater control of your situation when dealing with financial adversity.

1. Be pro-active. Schedule a time to meet with your lender to communicate the challenges you have encountered. While it’s not something anyone would relish, this early communication is a good step in building trust with your lender.

2. Be Prepared. Before the scheduled meeting, know where you are financially. Have your assessment of the financial loss both in terms of the actual $ amount and why it occurred. Whether it’s professionally prepared or done by you, have a current balance sheet and income statement that reflects the current situation. Having this information ready to share will provide your lender with what is needed to understand the impact to your business.

3. Have a Plan. Have a solution ready to offer that addresses the financial loss you have encountered. The plan itself will depend on many factors including the severity of the losses and more than likely may require lender approval. By exploring options ahead of time, you will be better equipped to develop an effective and realistic plan together.

4. Be professional and be patient. The reality of a financial loss is very stressful and can become emotionally charged as you must deal with its impact across many fronts. Your lender may need more time than normal to respond to your needs and that can add to the stress. Understanding more time may be required for resolution and maintaining a calm, reasoned approach in your conversations can provide the basis for reaching the level of communication necessary to arrive at a mutually agreeable solution.

Scotty Elston is chief credit officer with AgTexas Farm Credit Services in Lubbock, Texas. The lending cooperative serves 23 counties west of the Dallas/Ft. Worth metroplex and north to the panhandle of Texas. Cotton, dairy, beef cattle, and grains are the most prevalent commodities financed as well as a large number of part-time farms and ranches and rural homes.

By Carroll Merry

In the motion picture Close Encounters of the Third Kind, there’s a scene near the end where the humans are using sound and lights to communicate with the alien mother ship. When the alien craft takes over total control of the computers, one of the scientists comments “It’s the first day of school, boys.” There is obviously a lot to be learned from the advanced intelligence.

I can’t help but think that many of today’s farmers and ranchers as well as their lenders and financial advisers are facing their first day of school.

We are now a complete generation-plus removed from the Farm Crisis of the 80s when we saw a near complete collapse of American agriculture. The industry had been through land and commodity price booms with corresponding expansion of farms and ranches AND debt. Then came droughts in 1983 and 1988,  commodity prices crashed and the mountains of debt drove thousands to quit farming and many to commit suicide. Banks failed.

Those who survived vowed to never let it happen again. The Farm Financial Standards Task Force was organized and set out to develop uniform financial reporting procedures, formulas, critical ratios and guidelines. Ag Banking schools were established and classes were filled to overflowing. Credit policies were tightened with greater oversight by regulators.

Good times returned.

In the past 2 decades U.S. agriculture has again seen times of great boom with record high prices being paid for both land and commodities. Expansion has been great with neighbors buying neighbor’s land. Young farm couples have had money like their parents and grandparents never imagined. And they’ve used it to buy the best – for him the best and shiniest equipment with all the latest technological toys….for her the half-million-dollar home.

But the storm clouds were gathering.

A few years ago I was involved with an intimate meeting that included Dr. David Kohl from Virginia Tech, Freddie Barnard from Purdue and Tim Ohlde from the Ag Lending School. On the conference phoneline was Dr. Danny Klinefelter of Texas A&M. You won’t find a more powerful and influential group to discuss agricultural finance programs! The topic was financial management education for ranchers and farmers and it was stressed that a time of reckoning was coming. The  ‘go-go’ years of the early 2000s could not last.

They also noted that the need for education must also involve ag lenders. Today’s lenders, they observed, are also a generation removed from the 80s and have been through years of relatively easy skating in terms of ag lending. Most have never felt real pain.

Since that meeting in 2011 commodity prices have nose-dived, land values have ‘softened,’ farm profitability is skidding downward and signs of shakiness are being seen all across the ag community. If they haven’t already done so, every producer, lender, and financial advisor is urged to sign up for any and all programs that become available that may help them stay on top of their financial management skills.

It very well may be that for many that ‘first day of school’ has arrived.  

Carroll Merry is president of Countryside Marketing, Inc. While he is neither an ag lender nor a financial advisor, he has served as administrator of the Farm Financial Standards Council since 1993 and has been involved with the ABA’s National Agricultural Bankers Conference since 1988, roles that give  him a unique perspective as an industry observer.

By Kieth Raynor

On January 21, 2016 the Farm Financial Standards Council will once again team up with the staff from Farm Futures magazine and host an Ag Finance Boot Camp in St. Louis. If you have not attended one of these in the past, I strongly encourage you to consider going to this one.
 
I’m a CPA of nearly 20 years and I found the Boot Camp of earlier this year to be a great refresher course! And I can’t imagine how much information was taken home by those who were there who are NOT financial people.
 
I work in Dunn, which is a sleepy community straight south of Raleigh in east-central North Carolina. (We also have offices in Fayetteville and Sanford.).  Dunn straddles the border of Harnett and Sampson Counties and in September 2005, Sampson was ranked first place as the Best Place To Farm in the U.S. by Farm Futures. Agriculture here is mostly row crops with a heavy concentration of swine and poultry.   The row crops are predominately tobacco (pronounced ta-bacca for you non-Carolinians!), cotton and sweet potatoes with a few producers who still rely on the corn, wheat and bean rotation. In other words, we’re fairly diverse and not concentrated on just one commodity. And maybe that’s what made attending this year’s Boot Camp so interesting….the information available and the folks who were there were even more diverse! The Boot Camp was a great refresher for me as I am sure it was for so many of the 100+ folks who were there.

We often get lost in our own little agribusiness worlds of and think that everyone else has the same problems and opportunities we have. We also get used to doing the same things year in and year out using the same formulas and routines.  I have never been exposed to dairy farming but had a long and interested conversation with a perfect stranger at the Boot Camp about that industry.  The subjects covered included many topics I’d not dealt with for many years and there were actually solutions offered for handling client questions and needs right here in Eastern North Carolina. 
 
The audience is a broad mix of accountants, ranchers and farmers, and financial advisors from across the country, literally, and I was both surprised and impressed with how many ‘younger’ producers were in the audience. This is the generation who will carry on the legacy of their fathers and grandfathers to feed the world and they truly want to make sure their generation has a solid understanding of the financial end of their business.
 
The discussion leaders were the folks who actually write and maintain the Financial Guidelines for Agriculture documents. The relationships that I developed by attending are available after the conference and I know that if I run into a situation I have not been exposed to before, someone I met at this conference will be more than willing to talk me through it. It just doesn’t get any better than that.
 
The event is not free — it will cost you to get there and attend — but the information is invaluable whether you are new to ag financial recordkeeping or a veteran like me, a CPA who needs the occasional refresher to stay on top of the game.
 
See you there?

Keith Raynor is a partner with TRP CPAs, a full service accounting firm serving clients in agribusiness, construction, real estate, health care and government contracting. The firm is working at hosting its own local “Boot Camp” early in 2016 and has already found great support from among its current ag customers.

By Jim Casler

When considering benchmark data, the three important items to consider are accuracy, timeliness and applicability. The Benchmarking Part 2 article discussed accuracy of industry benchmarking data and the Benchmarking Part 3 article explored the timeliness of industry benchmarking data. The significance of using benchmark data that is relevant, or applicable, to your business and industry cannot be underestimated.

Different industries, different locations, different business models and different sized businesses have their own peculiarities and oddities that need to be considered when benchmarking your business operations. Different land costs, shipping costs, tax rates, length of growing season, number of degree days, etc all impact measures of performance.

For example, it might seem obvious that there isn’t much value in comparing the financial and operational performance of a 1,500 acre apple farm in New York to industry data for small manufacturers in Arizona. They’re totally different businesses, industries and location.

While the above is an exaggerated example, what about a 2,500-acre dry land row-crop producer in central Iowa comparing their business performance to industry data for specialty corn seed producers in Southern Michigan between 3,000 and 7,500 acres with 62 percent of their ground under water from 2013? Ah-ha, a little trickier, no? While this example certainly gets you much closer to an apples-to-apples comparison, it’s still not the most relevant information available. As an Iowa producer, you’d want to benchmark yourself against other Iowa producers, preferably to similar-sized operations in the same and neighboring counties.

To maximize the effectiveness of analyzing your business with benchmarking, the comparative industry data needs to closely correspond to your specific business – you know, apples-to-apples. Sometimes the data is readily available from a variety of sources. Other times, especially in small segment specialty ag markets, the data is much more difficult to obtain. The next installment in this series will look at how to obtain accurate, timely and relevant industry information followed up with discussion on what to measure.

Jim Casler is president of North Coast Ag Advisors helps family-owned farms with business planning, financial analysis and succession planning services.

By Joe Kessie

The Farm Financial Standards Council recommended using accrual earnings in 1991. Think about all the technology that has been adapted by farmers since that time. Even Round-Up-Ready soybeans were not introduced until 1996. That is why I am still amazed that after over 23 years of having the ability to calculate accrual earnings, so many farmers and their lenders are not using this tool to know how they really are performing financially.

I have been getting accrual statements from my clients since 1986. Accrual statements along with a simple trend sheet that calculates the “Sweet 16 Ratios” have been an invaluable tool for me, my bank, and especially my clients. All you need is an accurate balance sheet completed on the last day of your fiscal year-end (usually December 31st) and your tax return.

Think just averaging your schedule F income over several years gives you a good idea of how you are doing? If you can make decisions off of information that is 66 percent wrong then good luck. 66 percent was the difference between Schedule F versus accrual net income for a five-year period (2002-2006). This information came from a study done by F.L. Barnard, P.N. Ellinger and C. Wilson in 2010.

So if you are not already doing accrual earnings, take the steps this year to start. If you need help, all the resources you need can be found at www.ffsc.org.

By Todd A. Doehring

The Farm Financial Standards Council (FFSC) recommends 21 financial measures as part of its Financial Guidelines for Agriculture. A previous post looked at the Current Ratio (a measure of financial liquidity), and in this post we’re going to look at another measure of liquidity, “Working capital as a percent of gross revenues.”

The working capital to gross revenues measure (WC/GR) is a relative newcomer in financial analysis. Its primary benefit is measuring the amount of working capital needed, or to specify the size of working capital requirements. And, it helps determine this amount based on the total revenue (or sales) from an operation.

The FFSC defines liquidity as “…the ability of a farm business to meet financial obligations as they come due in the ordinary course of business, without disrupting the normal operations of the business.” Page III-2, Financial Guidelines for Agriculture, 2015. To paraphrase, liquidity is the ability to pay monthly bills, meet payroll, repay scheduled debt, etc. from current assets, without needing to sell business or investment assets to generate cash. This financial measure is used by many agricultural lenders as part of analyzing borrower creditworthiness.

WC/GR is computed by dividing working capital by gross revenues, and provides a percentage value that shows how large working capital is relative to gross (or total) revenue. Gross revenue is not the same as total cash receipts or gross income from a Schedule F. Rather, gross revenue is an accrual-based concept that measures the amount of revenue earned during a period, which is almost always different than the amount of cash received during a period.

A WC/GR measure of 20 percent or higher could probably be considered adequate, depending on the type of agriculture and the composition of current assets and liabilities. When price volatility is high, or revenue is expected to decline (as crop agriculture is experiencing presently), a higher percentage is obviously warranted. So, if an operation has revenue of $2,000,000, then the amount of working capital should be $400,000 ($2,000,000 X 20 percent) or higher, but even more (25 percent – 30 percent of gross revenues), would be advised when headed into a period of low income.

The WC/GR is relatively easy to compute and helps a business determine the amount of working capital they should be carrying. To learn more about this and other financial measures, you are encouraged to obtain a copy of the “Financial Guidelines for Agriculture” by visiting the FFSC web site at www.ffsc.org.

Todd A. Doehring is a Consultant and Director with Centrec Consulting Group, LLC, located in Savoy, IL, working within the food and ag sector. Todd works with producers and lenders in the ag finance, operations, and technology practice areas and also teaches a course at the University of Illinois on developing financial spreadsheet models and applications.

By Stephen Severe

Some of you who have a lot of gray in your hair will identify with this saying, the rest of you will wonder if the baby can actually go down the drain.

Enterprise accounting is an ideal way to understand the strength and weaknesses of your operation. For your enterprises to work ideally you need to understand the individual enterprises in depth. Especially those enterprises that are interrelated.

When I say interrelated, I mean those which in reality coexist together for the benefit of one or both. For example when I was growing up in southern Idaho we rotated potatoes, wheat, barley or oats. The enterprises were interrelated because we couldn’t plant potatoes after potatoes like we wanted to. So to grow potatoes we rotated a grain crop. The grain enterprise didn’t always make money. But, we would not stop using the grain enterprise because of the contribution to the potato enterprise.

Many agricultural operations have interrelated enterprises. Here at the Padlock Ranch we have a cow-calf enterprise, a grower yard enterprise, and crop enterprises. They are all interrelated. We raise most of our forage on our farm ground. The calves we background come from our own cow-calf enterprise. We have struggled with how to measure each enterprise’s contribution to the ranch. We don’t have local crops grown around us. If we did they could take the place of our farming enterprises. Therefore our crops are mostly grown to go through the grower yard and or the cow-calf enterprise. Because we have feed enterprises, we tend to background our own calves.
Because we have a cow-calf enterprise, we tend to grow forage crops. We continue to look at these interrelationships to determine if these enterprises are contributing individually and as a whole. We also evaluate them to see if another approach would be more beneficial.

Another factor to consider is what effect is there on your overhead and on your equipment pool if you discontinue one or several of your enterprises. We have to remember that unless you are willing to and can get rid of the overhead and equipment carried by an individual enterprise the other enterprises will have to bear that overhead cost.

By Jonathan D Shepherd

Basic business structures include sole proprietorships, partnerships, corporations (both C corporations and S corporations) and limited liability companies (LLC). LLCs are business structures recognized by state statutes that can be treated as a sole proprietorship, corporation, or partnership.

There are many factors that should influence a business owners’ decision regarding the best business structure to use. Liability and asset protection are often the reasons for forming a corporation or LLC and it is not uncommon to create one or more corporations or LLCs to separate land and building holdings from other assets. Usually, the desire is to protect the farm land from the risk of being lost in a lawsuit. Corporations and LLCs can help create a barrier between the operations of the farm and these assets. However, the recordkeeping practices and financial actions of the business owner can jeopardize this barrier.

When a corporation or LLC is formed, a separate legal entity is born. It is legally recognized as separate from any other business entity you had prior to the creation. You may still be the owner, but the newly created corporation or LLC is distinctly different. This is a very important distinction and an area where many business owners are putting themselves at risk of losing the protection they were seeking.

While it is strongly recommended that any business has its own bank accounts and financial records, it is required for corporations and LLCs. Corporations and LLCs do not have families or children so financial records should not include family living expenses. While the monies that are transacted in the corporation or LLC may seem to be yours, the way in which you access those funds determines whether or not the business is recognized as a separate legal entity, or as an extension of your personal affairs. There should never be money taken from the corporation or LLC to pay personal expenses directly. Monies from the corporation to the owner(s)/shareholders should be labor expenses, loans to shareholders, or distributions and if is recommended that salaries are established and dispensed on a regular basis from corporations.

Corporations also require other record keeping items including adherence to corporate bylaws that were created when the corporation was formed. Bylaws dictate how the business will be conducted, when director and shareholder meetings will be held, and how the corporate books will be maintained, among other items. Regular shareholder and director meetings need to be held and documented. This is especially important when making major changes or important decisions. These actions require meetings and documentation in corporate minutes which should be signed by directors or shareholders and kept for future reference.

LLCs are not required to have bylaws, but should have operating agreements, which are very similar to bylaws. An operating agreement explicitly states items such as ownership percentages, how profits will be distributed, voting rights, etc. While this is not required, establishment of and adherence to the agreement can be beneficial if the legal separation between business and personal affairs is ever questioned. Documentation concerning meetings and votes should be maintained within the LLC.

There are other factors that can affect the legal perception of your corporation or LLC as a separate legal entity as opposed to an extension of your personal affairs. The importance of treating your corporation or LLC as a separate legal entity cannot be overstated. This will maintain the integrity of its structure and help ensure that the protection you are seeking is legally recognized. It is suggested that you seek legal advice before determining which business structure is best for your operation.