Understanding your Farm's Financial Health

February 15, 2021

Video Transcript

All right, Good morning everyone and welcome to this next session of the Michigan AG ideas to grow with virtual conference. As we've done here at our session so far, I want to take just a quick moment to thank our sponsors that are up here on the screen. With their generous support. We've been able to offer these sessions free to all of you. And in addition, they have helped us be able to offer a scholarship opportunity that We we have for folks who are looking to get into college or are currently in college. And I will actually share the link for this in the chat real quick. For those folks that are interested, feel free to, to actually click on that. But we want to thank our sponsors for able, for being able to offer that to two prop, perspective college students and current college students. As part of this conference offering. Also want to take a quick moment to share a video, odd kind of highlighting some information related to Farm stress. Courtesy of our colleague Eric her Belsky. Eric highlights for us that carrying for crops animals creates a unique stress and pressure that can be hard on farmers and agribusiness professionals carrying for, for one's own health and wellness. In what is a high-stress profession, it can often be overlooked, but it's just as critical as carrying for the farm business itself. And so whether those stresses come from a financial issue or the stresses of everyday life, MSU Extension can help. And so I want to switch over here. We'll we'll actually go over to Eric's video. Hi, my name is Eric, our skin. I'm a behavioral health educator with MSU Extension that focuses on farm stress with a farm stress tip. We know that farm is a stressful occupation and the Centers for Disease and Control ranks farming among the highest occupations for loss of life by suicide. How would you approach someone that you're concerned about taking their life by suicide? Research suggests that asking them directly is the best approach. Are you having thoughts of suicide? Asking someone if they're thinking about hurting themselves may have a different response than asking if they actually are thinking about suicide. And so what do you do if someone says yes, The biggest thing is don't leave that person alone. Call for help, take them to a health care provider, take them to a hospital, or if it's a hostile situation, call 9, 11. Another resource is the National Suicide Prevention Lifeline. And that number is 1800 to 738255. And I know this can be conversation and a difficult thing to deal with, but know that there are a number of supports and resources that are available to those that are struggling. And many of those can be found on our MSU Extension farm stress website. Know that there are a lot of people working very hard behind the scenes to help support you as you support us. Thank you and have a great day. And if you'd like to learn more about farm stress, please join us on Friday this week, February 19th at 11 AM. For the mending the stress fence session. You can find the Zoom link for that and the pass code on the final schedule that was emailed to you. Okay, so should be back on our PowerPoint here. The next thing I want to again, welcome everyone to this session on understanding your farms financial health. I'm your speaker John report. I am the farm business management educator in the southwest part of the state of Michigan here. On to start out with kinda want to gauge our audience a little bit. I have a couple of poll questions that we want to ask. See those pop up here on the screen for you. The question is, how often do you review your financial statements? And these would be your balance sheet, your income statement, and your cash-flow statement. And then additionally, do you use these documents, et al, in your farm decision-making? So we'll take just a moment or two here we get people to fill out the poll questions. Can get an idea where our audience is that today, we'll get a couple, couple more responses on this here. Another one here that jumped on. Just a few more. And then we'll, we'll move on to our content for the day. Again, how often do you review your financial statements? This will be your balance sheet, your income statement, and your cash flow statement. And then do you use those documents at all in your farm decision-making? Just a couple more seconds. Okay. All right, We'll go ahead and close that out. Okay, so as we think about the farms financial health, there's a couple of things I want to make sure we kinda highlight for everyone this morning. And the first thing is to really think about understanding the value behind knowing what the health situation is for the foreign business. Not to do that, we've got to think about how we're going to sample the numbers. We need to really dive into that. And then we need to spend some time being able to analyze the information. But more important once we've got the numbers and we've, we've kinda analyze them a little bit to understand them. We want to be able to use what we've learned to help us make decisions and ultimately the foreign businesses about trying to make money to be profitable and to able to, to pay off debts and eventually build the overall value of the business itself. And so we want to try to use that information in order to do that and make those kind of decisions. And I think to start out with the best weight in terms of understanding the value is to look and maybe focus on a valuable activity that is done on many farms and that soil sampling, whether we grow crops, fruits, vegetables, or forges the value of soil sampling and maintaining our soil health is pretty widely understood. And so maybe there's some parallels there that we can try to look at. So as we, as we work through that, let's talk about why do we sample our fields? And so we need to know the amount of each nutrient that we have in the soil. We want to make sure that our pH is balanced as appropriate for, for whatever it is that we're trying to grow. We need to know the potential of our soils and look to the organic matter or the cation exchange capacity or CEC for our guidance on what that capacity is. And then ultimately we need to know what are potential yield and profits are going to be for that particular field or the soil within that field. And so soil sampling serves as the foundation from which we can operate and make decisions from a lot of our production activities. Well, as we think about the soil health and financial health, there is a lot of similar questions that we start to ask. How much do we have to operate with? How much do we need to add? Do we have available assets that can help? Are we really making money? How efficient is our production? Are we operating within or exceeding our farms capacity? And then ultimately, as we wrap up these questions in our mind, we think about of the options we have, which ones make the most sense for our farm. And so you're using all that information again to help make decisions. So if we understand the value and we start to make some of these comparisons and ask them questions. Well, we know how to go take soil samples for the most part. How do we go about sampling the numbers we need for the financial health analysis? Well, we spent a lot of time talking about financial statements and on, I'm not gonna spend a lot of time today going over definitions to stream or walking through a lotta in depth of the how to develop these, these statements. But really kinda over you're thinking about what they do. So a balance sheet, most folks are familiar that it's a snapshot in time of the farms financial condition that's usually done at the end of the year. And it indicates what you own, which are your assets, and then what you owe those liabilities or some folks will refer to it as debt. And when we start to is we want to try to get to analyzing information. We're starting to evaluate the change between balance sheets. So we want to kind of look from one year to the next, how did things kinda change? And we want to be able to have that information because when we go to our income statement, our income statement is really focused on the operating activities, what happened in the checkbook over the course of that year. So anything we've written a check for or any money we've received. Basically, as you think about the things that transaction that you capture and a checkbook, that's kinda what the income statement to some degree it's looking at. We also want to capture the value of the change is often inventory changes that we referenced in the balance sheets from year to year. A lot of cases we're looking at what are the changes between prepaid expenses or the feed we have stored or crops in the bin that we've been storing. How have those things changed from one year to the next to impact kind of that year. We also want to look at depreciation. Now this is not the same as the depreciation we're talking about on your taxes, but more of this economic depreciation. Because your farm, it might be different in how you value assets from one farm to the next. But as we're looking at, at my example here of of I got a piece of equipment. I've got an International Harvester 1066 tractor. You know, what is it worth? Is it wears down another year. It's got a little bit more wear and tear at the year older. How much is it worth because of that? From one year to the next? And we try to track that Ahmed income statement to kind of give us an idea of what we've we've lost in value because aged. Now, I do know for those that are on the call that are red tractor fanatics, that whatever their tractors are worth, it's worth more than a John Deere. I know that's going to be the instant answer to that. But we want to think about how does that impact the value changes over the year impact what happened in addition to what's in our checkbooks. And so then if we think about our other statement, we move to our cashflow statement. This is where we start to focus on the cash and how it was used. And so we're talking about operating activities. And investing activities and then of course financing. And so really it's kind of a combination of the information we collected from the income statement and the balance sheets. And really if you think about it, how did the checkbook activities, so our kind of our income statement effect the value or net worth of the business that we typically look to from the balance sheet. And really what we're trying to look at and gather from these pieces of information, these documents is how viable or sustainable is the overall business. And so to kind of help illustrate that, we've got kinda this little pictograph here of the different financial statements and you kinda see where certain parts kinda translate to other, other statements here. And really what we're getting at is that financial statements are individual parts of the overall health story. Cuz we're trying to get a handle on what is that whole story for the farm business? Is it healthy? Is it struggling? And we ask the same kind of questions. When we start to look at our soil samples, we look at all these individual pieces of information. And how did they all tie in together to kinda help tell the, the soil health story that we look for in a particular field. We're using these financial statements to do the same thing, but from a financial health perspective. So we've talked now about where to, where to start sampling the numbers. One of the questions is if in comparing again to soil sampling, when do we take the sample? And the answer is at least once a year. But truly as often as needed. You may need to look at those more often than just once a year, but at the very least we recommend once a year. The ideal time is often after the fiscal year has ended. Some operations have a fiscal year that starts and stops on in December or January. Others may be june, July, whatever that year is for the farm operation. At that time, at the end of those years is often a good time to kind of stop and take a, just a quick measurement of where that financial health is. For grain operations. This could be after harvest, could be prior to taxes. So in that December to February time frame, the idea is that well kept, accurate records during the year can help in this process. So if you're doing a good job during year of keeping track of your information, when you sit down to, to actually analyze the information, you've got a lot of helpful pieces already there. And another idea of when to take the sample is preferably prior to meeting with the lender. So that begs the question of, well, why before the lender meeting? And the reason for that is that the lender wants to see the farm managers lead that financial conversation. Where is the farms financial health at currently? What are the plans for the farms future? How are we going to address those challenges? Head on what obstacles exist or maybe are on the horizon. And this really kinda gets back to this idea of discussing the plan. Not just the problems to being successful. If you understand where your farmers financial health at the time of that meeting, you can really discuss that plan and what's your opportunities are to move forward and how that lender can be really a part of that, that success story going forward. What you don't want to do is you don't want to wait for the lender to tell you about the farmers financial health. If the lender is, is discussing things on the farm, is the one leading the conversation. There's a problem. And you want to try to avoid that because you kinda want to avoid that what I call the church revival and this loss of lender faith because they're leading the conversation that tendon give them this idea that you don't really understand what's going on with your fine, your farms financial position and current situation. And it makes it difficult for them to really want to invest and work with the operation. So going in, actually with that information kind of known for you, helps the other ideas that you want to kind of get into this idea of treating the lender as this trusted partner that has an invested in the farm business. So as you think about working with other members of your farm business team, whether nutritionist or agronomist. You want to make sure that you're preparing and understanding where your farm situation is. So you can give them information to help you be successful and have them be able to provide some help as well. So now that we've talked about sampling the numbers, let's talk about how we analyze those numbers a little bit. And to do that, we really need a roadmap on how to understand what those financial statements are telling us about the farm business. And so a lot of cases we recommend people use this foreign financial scorecard to kind of give us some indicators and references to what the whole story is for the farm. Now, we're not going to go through the, the actual ratios are equations today at any kind of depth. But more focused on the concept of what we're trying to find out from this information. So let's start with thinking about liquidity. This is often something that comes up when you're looking at the farms financial position. And so when we talk about liquidity, we're often talking about working capital. And that idea is how much cash do we have available on the farm? Well, let's, let's go back to our, our soil health comparison, our soil sampling thoughts and when we talk about how much cash we have available. While on soil health, we often talk about how many nutrients are available in the soil. And most folks are pretty familiar with if they do any kind of soil sampling and looking at nutrient levels. This picture is kinda pretty familiar to them. Well, we can kind of do the same comparison on liquidity to think, well, where I is our, our working capital position. How much cash do we have available? Depending on where the farmers that do? Do we have things kinda lined up well, that we have things in abundance? Or maybe we add a level that things are kinda restricted. And so you think about how much of that cash is available for the farm to actually use. From a ratio standpoint, I recommend people focus on the working capital to gross revenues. Because this really asked about how much cash do we have in reserve to meet the needs of the farm? And so when you often think about this in terms of an area to try to shoot for. Let's kinda focus down to this idea of generating revenue. So as we think about having enough cash in reserve are talking about if we generate revenue for the farm. And let's just say for every dollar we've generated on the farm, how much do we want to have in reserve to meet our needs? And what are financial scorecard tells us is we want to have about 30 percent. And so if we want to have about 30%, that means in addition to that dollar, we need an extra 30 cents in working capital to actually be able to be in reserves. So you're trying to kinda keep that level available if you need it. And let's also think about solvency. So this is where we start to talk a little bit about debt. And when we talk about debt structure, how many of the assets on the farm are bound or tied up? And so when you think about lenders taking a lean or having any kind of loans out there. Those, those assets are kinda bound up or tied up by debt. What kind of continuing this soil health comparison idea, this talks a little bit very similar to our pH levels, which indicate what nutrients are bound by the soil or, or what are not bound and actually free for, for use by the plant. And so that same concept we're pretty familiar with this pH scale that we want to kind of keep things in balance. Well, we, we kinda see a similar things from a balance sheet scale that where, where to things kind of fall in terms of the balance on what we have, in terms of our assets and what's actually free for us to use. And to be maybe even possible to be leaned against or for additional debt we want to take on. And so the often the most common ratio for this is a debt to asset, where we're talking about how many farm assets are available to borrow against and how many of those assets are bound, are tied up by debt. And so as we think about this from, again, we're thinking about things that really simplistically, if we've got farm assets valued at a dollar and our debt to, debt to asset ratio is 85%. Well, that means that of that dollar we've really only got about 15 cents still available to borrow against. And that may or may not be a whole lot dependent for what it is our needs are going down the road. So kind of thinking of this thing from that dollar level, if you're at a high debt to asset ratio, a lot of your assets are bound up and just not free to use. Let's think about profitability next. This is often the big one that fo, folks want to think about. And are we're talking about this idea of, are we making money? And how much revenue of that money do we get to keep? And so as we think again about our soil health comparison, did what we put in the soil. And we're thinking about our inputs of fertilizers, seed, maybe chemicals lead to a positive return that's cash for the farm. If N is kind of this idea of it's not Nestle and what you make, but what you get to keep, that matters most. So we often talk about cost of production and we'll use corn. Here is an example. This is the idea of what we've put in. If we've got $3.80 for our cost of production and the current market price is $3.85. Well, that means that our net profit, net farm income per bushel is about $0.05. And so a lot of cases that were talking, there's not a whole lot of profit there that we're able to keep and utilized for some other things. Now keeping that profit in mind, we've got to think of some other things down the road here that we want to use that profit for. And so we're going to kind of come back to that a little bit later on. The other thing I want to highlight two is as we start to think about financial efficiency, we have several ratios that look at this. But to start out with, I want to share this example of kind of what I consider a, a typical photograph on, on many farms where we see that we've got two pieces of tillage equipment here. And instead of pulling them both separately across the field, we want to try to be more efficient, so we want to pull them both at the same time. And so this is often considered a more efficient way of preparing the soil for crops to be raised. There's a lot of similar examples of this. You can find working on dairy operations, beef operations, fruit and vegetables, where you're combining activities, multiple activities into to one operation to be a little bit more efficient. Well, we think about the same thing from a financial aspect too, of how well do we make money and how effectively do we use our farm assets to generate that money or to generate that income? So as we're thinking about our soil health comparison here, how effectively are we utilizing our soils to reach our yield goals? This is the same type of thought process. And for example, if we're matching the hybrid or a seed variety to the soil type on the farm. Should we plant corn hybrid that needs a higher planting population and lots of water on a dry sandy soil. It's not really being efficient with our, with our inputs there. And not really utilizing the capacity of the operation very well. And so we think the same thing when we look at this operating expense ratio. In this indicates how much remains to pay interest to pay principal and family living after we've kind of covered this operating. And kind of coming back to this idea of if we generate $1 by the farm and say we have an operating expense of 80 percent. Well, that means we've only got $0.20 of every dollar left over to pay for our interests, our principal and family living. Is that really considered an efficient number for our operation? Do we need to be somewhere? But depending on your debt structure, depending on how many people are taking, family draws from the operation. Do we need to have a much more efficient operation to be able to put more of those pennies towards covering those additional things, pass that operation. And that ultimately leads us to finally looking at repayment capacity. And so when we're thinking about this, we think about at the farms current size. Is it operating at above or below its capacity to pay term debt? So far, so ill-health comparison, I go back to what I mentioned earlier about organic matter and our cation exchange capacity. These are indicators of a soil's capacity and yield potential. Well, we want to think the same thing when we're talking about the financial situation for the farm. But our farm example here is you think about if, if we applied fertilizer for 200 bushels of corn, but our soil is only capable of a 150 bushels per acre. Were our expectations reasonable? And, and that's kinda what we want to think about when we kinda come back to this repayment capacity, which really talks about a Farms cashflow. And so an example, this would be to use our term debt coverage ratio, which really talks about has the farm generate enough income to cover its, its debt payments? And we're talking about these, these term debt payments. So not your annual operating, but more or less longer-term debts. And we kinda come back to our efficiency example from before, where we said we had 80 percent operating efficiency in that $0.20 left over of every dollar I had to go to to help pay for things. Well, can your, is your debt less than that? And we think back to our efficiency of we want to do, we're pulling those two piece of equipment at the same time. We're trying to be more efficient of the operation. So maybe we've, we've got a couple of things we put into motion here, and we've got a few loan sitting out there to try to get us in that position. But when we go to actually try to move forward and do this, maybe we don't quite have enough spending power, enough income generating power to actually move, move those two piece of equipment down the road. And so we think about that from that financial aspect. Or do we have more debt? Are we making higher debt payments than one? Our farm is actually capable of handling, not generating enough income to actually cover what we've got set up for debt payments. So as we move forward here, we want to be able to take now that we've analyzed this information and start thinking about how are we going to use what we've learned. And so what we really come back to is we started with understanding the value, where we talk about the foundation from which we can operate and make decisions. We also want to be able to sample the numbers where we're gathering those financial statements. And we're talking about analyzing information which is reading and understanding that farm financial scorecard and what the ratios mean. So at this point, I think we're ready to use this information. Well, how are we going to use that information? We want to make decisions. We use those ratios. We use that information to try to tell us what are the farm specific strengths? And then just as important, what are the specific vulnerabilities that exist out there? What are some things that we noticed are maybe some areas of concern are we do we have a low term debt coverage ratio where we've got a lot more debt payment that what our farm can generate income for. Do we have a high operating expense ratio where we're spending a lot of money, putting a lot of cost of production, lot of input cost into generating what we're trying to raise. And we're not leaving ourselves enough money at the end to be able to cover those payments. Or maybe work. We've got too many family members on the farm that are taking wages, draws from the farm. And we're just not having enough income to cover those type of things. So we kinda highlight what are some of those vulnerabilities were worried about. But then we also want to think about how we can be more accurate and more effective with our decisions. So does the farm have the capacity to manage those vulnerabilities? Some of the examples I mentioned, what are some different things that the farm can do to maybe rethink how some of those things are managed. If you're talking about input, cos, if you're talking about debt structure, there are some things the farm can do to manage those differently, to kinda help make those little easier. Can the farm also capitalize on its strengths? There are often cases where the farm does some things very, very well and can capitalize that and actually continue to do more of those things to help to generate income. To maybe cut down on expenses and maybe think about getting back to those debt payments and structures. Can, can we rethink some of the things we're doing to help maybe redirect a new plan forward, to work with the lender, even to restructure some of those debts. And that kind of leads into that thought. Outside assistance, help in these areas. And is that the lender that that needs to be talked to, is it a case of maybe the concerns that we're seeing are more of a production area. So we need to talk to an agronomist or nutritionist. Maybe looking at the nutrition plan for the feet on the livestock operation, are looking maybe at the fertilizer plan for the crops, are the forage is being grown. Who are those outside folks that could actually help provide some assistance? It also allows us to be a little bit more realistic and reasonable as we think about, well, what assistance is actually available. We kinda find these areas that we're concerned about are these areas of strength we want to capitalize on what's really available, what options meet the needs of the farm. Because sometimes there's a lot of assistance available, but it's not the assistance that's really needed. And then which options actually meet the farms expectations? So we think back to our example if we want to be more efficient and that's our expectations we want to get to being it that's efficient level in and try to do a lot of things on the farm without a lot of extra work involved, like extra labor, extra cost. But then at the same time, what options meet our expectations? But then at the same time thinking, are our expectations reasonable for us to be thinking about? And so there are resources that I want to highlight are available to help the MSU Extension farm business team. And I've got the the web link up here. I'll make sure those actually get into the chat. And also there's a bulletin on the, this presentation today, understanding the farms financial health, basic components to a successful business that I want to highlight those for, for folks that you can actually go and read that document as well. It's kinda where this presentation is based from. And there are other resources that you want to kind of highlight talking to as well. Thinking about your commodity marketers. You've got insurance agencies, you've got your lenders that you can talk to. And as I've mentioned already, you have nutritionists and agronomists that when you've looked at this financial information, you've kinda highlighted where the concern areas are and where your strengths are that you want to capitalize on. Reaching out to some of those folks can kind of help direct you on how to make some changes forward in the operation. But ultimately the main thing to remember is that although it may not feel like it at times, navigating your farms future is still largely up to you. And understanding where your farms financial health is, put you in the driver seat to understanding what the situation is and what decisions you can make moving forward to being successful or to continue seeing the success that you've enjoyed maybe for the last couple of years. And that all starts with understanding that foundation piece of of where the farms financial health actually is.