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Ag Finance 101

Haviland State bank is providing our customers with some priceless information on the basic principals of Living/Working in the world of an agricultural business. See below for more information.

Are you Profitable Enough?

How things have changed. I'm sure you can remember when equipment was much smaller and when tilling, planting or harvesting described most of your day-to-day work on the farm. A no-till farmer would have been a nice way to describe your behind-schedule neighbor. A yield monitor was that same guy who wanted to know "what your wheat made"? then reported his did 2 bushels better.

As agriculture continues to evolve into a mature industry understanding technology and managing the details of your operation is essential for survival, not to mention growth. The diverse nature and size of agriculture has slowed the process of mega-business entering the mix compared to other industries. Different climates, soils and crops give each region of the country it's own set of distinguishing features. Adding diversity through livestock further differentiates one farm from another. Even so, the big are getting bigger. This certainly isn't news to you. It's all around you. Real estate values continue to climb, fueled by strong interest from recreational buyers as well as producers with the means to expand their own operation. Without a doubt agriculture has become a more competitive, aggressive and thin-margin business.

In such a complex business environment, attention to detail is paramount; Especially financial detail. It is very common for today's producer to have a primary focus on production. Bushels, pounds, tons, acres and dollars per unit dominate most agricultural conversations. By nature, these numbers are the best measures of our daily efforts. It would be foolish to suggest that these numbers are not important to a successful producer. They are. Long-term trends however, are usually measured differently. Financial numbers and ratios are generally the best score card of the overall health of the operation. The successful producers in the long run are those willing to take the time to be a top producer of their commodity as well as a savvy manager of their finances.

Crop consultants, seed companies, herbicide manufacturers, and equipment manufacturers all provide critical, technological information that improves efficiency and production. Does your financial health get the same attention?

To get optimal returns on your efforts as a producer without encountering too much risk, a manager should be familiar with issues such as liquidity, profitability, debt service coverage and leverage to name a few.

Some producers choose to scout their own fields for insects, water requirements, herbicide needs etc. Most however use a professional service that has some testing equipment as well as level of knowledge and experience that comes from not only scouting one field but hundreds of others. As certain threats to a particular crop are evident on one field, the scout will be more aware of it's presence in others and may be able to identify it sooner on your farm.

In a similar way your Banker should be the same kind of help in your operation. In today's competitive lending environment money can be borrowed from numerous sources. But, finding a lender that wants to take the time to understand your unique operation and develop a plan that fits within your tolerance for risk may not be so easy to find.

For example; ARE YOU PROFITABLE ENOUGH? The question itself implies that there is more to long-term success than just being profitable. The simplified formula for this particular calculation is; NET INCOME + DEPRECIATION + TERM INTEREST PRINCIPAL AND INTEREST ON TERM PAYMENTS (one year of p&I) + MANAGEMENT WITHDRAWAL + INCOME TAX. The result of this formula is called Debt Service Ratio. The result of the calculation must be 1.0 or greater in order to have "debt service" for that particular period.

As suggested above, it is entirely possible to be profitable and owe income tax on the profit but still be loosing ground (loosing earned net worth) when you complete your next balance sheet. Additionally, it is also possible for a tax liability to exist with no cash, crop, or line of credit with which to make payment.

Each number in the formula should be given adequate attention and be understood by the producer. As Lenders at Haviland State Bank we feel it is important to give our borrowers the information they need to make the best decisions possible. Are you profitable enough?

Cash is King

Who really has cash these days? It seems that every dime is already spoken for before the ink dries on my grain check. Sometimes my cash position makes me feel more like a Joker than a King! What does "having cash" mean to an agricultural producer anyway? Does anybody really have a significant amount of cash on hand?

Different businesses have different meanings for the term "cash". For the sake of clarity however, the term in this article is intended to relate to the financial position of the agricultural borrower.

Imagine the last balance sheet you signed. There were most likely 6 boxes or at least 6 different categories. They include 3 classifications for assets in the left hand column and 3 classifications of debt in the right hand column.

The top left box is titled Current Assets (CA). The current assets are those things that truly are cash such as savings and checking balances as well as those things that are "close" to cash such as accounts receivable, inventory, livestock to be sold, prepaid expenses, investment in growing crops and such. As a general rule these assets are soon to be cash or recently were cash with the purpose of trading them back for cash in the near future.

The top right box is titled Current Liabilities (CL). These are debts that will require cash within one year in order to satisfy the terms of the loan. Specifically, they include accounts payable, accrued interest, accrued taxes, rents, leases, credit cards, operating loans and usually the current portion of long term debt (CPLTD). Current Portion of Long Term Debt refers to the principal portion of term debt. e.g. You have an annual payment for tractor financing in the amount of $10,000. For simplicity let's say the interest portion of your payment is $3,000 and the principal portion is $7,000. For that particular payment your balance sheet should reflect CPLTD of 7,000. The remaining debt on that note would remain in the intermediate debt category.

Several different standards have been created to measure the health of a producer's cash position. Additionally, different analysts use different terms to describe the same measurement. But whether you call it cash position, liquidity, or working capital, we are still referring to the same set of numbers.

Let's start by calculating a Liquidity Ratio; this is done by dividing CA by CL (ca/cl= liquidity). See Table Below

Another measure would be to calculate Working Capital; this is done by subtracting CL from CA (ca-cl=working capital). In this example working capital would be 5,000. Or in other words if the producer pays off all of his current liabilities with his current assets he has 5,000 remaining.

Some analysts might say that this producer has a cash position of 5,000 dollars.

Now that we have this information, what do we do with it?

For starters it is important to analyze this number in relationship to your whole balance sheet and income statement. For instance, look at how the cash relates to one year of operating expenses or one year of principal payments (CPLTD).

For the most part these numbers are a good indicator of a producer's ability to withstand adversity; and in agriculture, as you know, adversity will come. Such factors can be commodity prices, weather perils, and disease to name a few. If a borrower has little or no cash, any significant adversity can cause a major disruption, if not the end of the operation. On the other hand a borrower in a stronger cash position can withstand some adversity and can be ready to take advantage of opportunities when they come.

Some factors that cause cash strain are less manageable than others. A drought is hardly manageable. On the other hand, over expansion, capital purchases and family living draws, are choices that are highly manageable.

Regardless of your preference of analysis and terminology it is critical that you understand your cash position. Knowing the relationship of these numbers should make planning and decision making an easier process. One man's adversity is often the other man's opportunity. And that is why Cash is King!

We would appreciate the opportunity to work through the particulars of your operation. Please contact Stan Robertson or Trent Jacks at Haviland State Bank (620) 862-5222.

Haviland State Bank; The way hometown banking is meant to be.

Trent's e mail
Stan's e mail

We are interested in your business.

Lifestyle of Business

Are you in business for the sake of business and profit? Or are you in business to enjoy the lifestyle it provides? Maybe your farm/ranch allows you to enjoy both. Whatever the case we simply want to share some observations from Banker's side of the desk. This is not intended to be an exhaustive or scientific study but rather simple observations of the habits and tendencies of a wide variety of producers over time. Even though a lot of the individuals we deal with are agricultural producers, the tendencies seem to apply to business owners of all types.

As a business owner how often do you review:

  • Cost of production
  • Profit per year/per acre/per head/per hour/per bushel etc.
  • Net worth
  • Trends of the market
  • Risk factors for your business

The list could go on but you get the idea. The next question to ask yourself is "Why did I review these elements of my business?" Was it because your lender required it or were you trying to improve your management of the variables?

Without a doubt we have recognized that it is the profitable producers that generally have a strong sense of their own numbers. Even if they rely upon a consultant or an advisor they still are very aware of where they stand. On the other hand other producers never take the time to analyze their own numbers. They're making everyday management decisions without knowing how they effect the overall operation. Choices seem to be based on "doing what I have always done" rather than adapting and evolving with the various elements of business.

It is rare that someone would work through all of their financial and production data and then make foolish management choices. Information is key to management. The old adage that ignorance is bliss seems to hold true for "lifestyle" producers but not profit driven producers. A lifestyle only operator tends to lean away from critical information for fear that the knowledge may require a change in lifestyle. The profit driven producer seems to lean toward obtaining and understanding the critical data. He wants to know as much as possible about the operation in order to make the best decisions as they arise. This profit driven producer can't sleep well if there are too many unknown factors encircling the farm.

These tendencies reveal themselves in different ways. A common desire for most any operator is to purchase or rent the property next to his own. While this has it's obvious appeal, it will only benefit the overall operation if it can fit within cash flow limitations for a purchase. For considering additional rented land it will only be a positive addition if the new acres can be operated at a profit. Knowing your cost of production is critical to making the right decision. More acres are often the "beginning of the end" for some. While economies of scale are important, a money loser is still a loser. On the other hand if it works, hurry up and sign the papers. In a similar way equipment purchases have the same effect. A new piece of equipment must be afforded in the cash flow. A profit driven producer knows what his cost per acre or per hour will be for any equipment in the line-up. In fact, by knowing what the economic depreciation of an item is over a period of acres/hours/years, a good decision can be made regarding the update of any piece of equipment. In this age of technology trading for new or newer equipment may be the most cost effective choice. The decisions should be made by weighing all the factors rather than a preference of lifestyle.

Another area of distinction among producers is they way they manage risk. Every business owner faces numerous risks. Two of the most notable risks in agriculture seem to be rainfall and commodity prices. Outside of irrigation there is not much hope for managing rainfall. Price risk however, does have at least some level of control. Even though the grain and livestock markets have both seen large swings, they both have afforded opportunities to manage price risk at a profit. As you also know risks related to weather can be partially mitigated by using insurance products.

The lifestyle operator will generally concentrate on production only at the expense of marketing and other risk management. After all that's what he does best not to mention that's what he enjoys the most. The profit driven producer has a broader plan. One example of dealing with the bigger picture would be marketing a crop (or part of a crop) 12 or even 24 months ahead of the cash sale if the opportunity is present. Another example is retaining an "option" to take advantage of a positive market move after the cash sale has occurred. While these tasks seem burdensome and tedious to some, marketing and price risk management are critical pieces of the management puzzle.

In short, a lifestyle producer will generally take the path of least resistance. He will work very hard at the tasks he can master but avoid the uncomfortable issues. The profit driven operator generally chooses the most profitable option. He has the discipline to face even the most arduous task. He eventually will enjoy a profitable lifestyle!

At Haviland State Bank we know that the answers are not always black and white. But we also want to serve our producers by providing them with good information and the financial tools to succeed.

Stop in or call one of us to discuss your specific operation.

Haviland State Bank; The way hometown banking is meant to be.

Trent's e mail
Stan's e mail

We are interested in your business.

Calculating a Liquidity Ratio

Example of calculating a liquidity ratio
Current AssetsCurrent Liabilities
CheckingOperating Note
GrainIncome Tax Due
GrowingcorpAccrued Interest
Invest: 5,0001,500
Calves to sellCPLTD
Prepaid FertilizerSeed Financing
Acc/ReceivableCredit Card
Total CATotal CL
Current Assets
Operating Note
Income Tax Due
Accrued Interest
Invest: 5,000
Calves to sell
Prepaid Fertilizer
Seed Financing
Credit Card
Total CA
Total CL
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