As producers look to year-end, some will be focused on managing income taxes. The new One Big Beautiful Bill Act extended existing tax law and added a few new concepts. However, avoiding taxes shouldn’t be your focus for managing your farm business.
Here’s one big why: If you are successful in not paying taxes for several years, one shouldn’t be surprised if a lender doesn’t want to finance you any longer.
Instead, focus on managing these five financial areas:
- Liquidity. It’s measured by looking at working capital and the current ratio.
- Solvency. Also referred to as a balance sheet, it is identified in your net worth statement.
- Profitability. This is the difference between income and expenses.
- Financial efficiency ratios. They look at what percent of the gross income went to pay interest, operating expenses, depreciation, reinvestment in the business and family living.
- Repayment capacity. This measures your ability to service current debt.
Manage cash flow
The first area that a producer should manage is cash flow. One needs to understand how much money is going out and how much is coming in.
Keep in mind that a business can be profitable and have negative cash flow. Buying land or making large capital improvements may result in this occurring.
Conversely, a business can have positive cash flow and still be losing money. Liquidating inventory or selling capital assets can help with cash flow when facing operating losses.
I like to say, “If you don’t cash-flow, lenders will start to take things away.” If you are struggling with cash flow, analyze where it is going and look for ways to increase cash coming in.
Moving debt “down the balance sheet” is a common strategy to deal with cash-flow issues. You take operating debt that you can’t repay and borrow against long-term assets such as land by restructuring the debt and stretching out the payments.
Remember that this will impact your ability to cash-flow in the future. Lenders often focus on family living expenses and land rents when looking for ways to minimize the outflows.
Year-round balance sheet
The basis for most financial analysis is the balance sheet. Typically looked at once a year, it’s a continuous process with double-entry accounting.
The balance sheet gives a “snapshot” picture of how one is doing financially. Balance sheets are typically done in one of two ways, but in ag, we have many different versions:
Market values. On the day you complete the statement, you value everything as if it was sold. The value of a bushel of corn is its worth at the market, minus delivery cost.
Cost basis. You enter the value at the initial cost, minus the accumulated depreciation. So, the cost of raising a bushel of the given crop.
There might not be much difference in the two numbers, depending on the asset. For instance, a piece of land bought 30 years ago for $2,000 an acre with a market statement might value at $15,000 per acre based on the “market” and only at $2,000 an acre based on “cost basis,” giving our balance sheet a much different value.
On ag balance sheets, we often use a combination value that reflects a value based on how much debt the land could service if it was rented out for cash. Often, neither type of balance sheet shows deferred income tax liability, which frequently is a significant cost at retirement.
Do you have debt capacity?
The most concerning number I see on financial statements is debt repayment capacity. With high grain prices and large government payments, we saw producers with a 5-to-1 ratio, indicating that they could sustain five times more debt than they currently have.
That is based on a “snapshot in time.” And as margins decline, those debt repayment capacity ratios can drop like a rock and even go negative.
Make financial management decisions based on your profit statement, not your tax return.
For additional information, search for “whole farm financials” at extension.iastate.edu. The University of Minnesota Finbin webpage also provides a great source of information for benchmarking at finbin.umn.edu.