“You can lie to your banker, you can lie to your tax man, but don’t lie to yourself.” This quote stuck with me after a recent meeting with a farm family and their financial consultant, Sam Bachman, of UnCommon Farms.

The point he is making is it’s not unusual for farmers to carry multiple sets of books – perhaps one set using cash accounting and another using accrual. You may have a balance sheet for the banker that looks different from the one you show your financial advisor.

Sam and several other respected farm financial consultants: Shay Foulk, Ag View Solutions; Grant Wiese, FARM640 and Ben Gordon, Fractal Agriculture recently shared their ideas on how to expand during a downturn in the farm economy.

Know your numbers

They overwhelmingly agreed it starts by knowing your farm’s numbers – in particular, key financial metrics and historical trends from your balance sheet and income statements. This is especially important as the price of corn has fallen from $7 to $4 per bushel, crop input and land costs have remained stubbornly steady, and the super-low interest rate environment is likely over. Whether we’re in a downturn or a market correction, these types of cycles have occurred in agriculture for the last 50 years.

As Sam says, this is really no fault of farmers, but rather of the industry itself. Farming may be the only industry where you can lose 40% of your top-line revenue potential in two years. To boot, farmers are the weakest link in the supply chain but bear the greatest amount of risk.

How to manage this

1. It starts by understanding the industry, its cycles and your numbers. Numbers don’t lie, and they can help you determine how much of the business you own to help mitigate these risks, or how aggressive you can be to explore new opportunities.

2. Use a true market valuation of your assets, not conservative numbers which may not give you an accurate picture. It may even be worth going through the exercise of hiring appraisals of your assets: your farmland, farm building improvements, and farm machinery and equipment.
3. Don’t fly blindfolded. Assess the risk profile of your operation using key financial metrics. For starters, download your own farm financial scorecard such as the one below available from the University of Minnesota. Ratios can easily be distorted and misunderstood, so talk to someone who knows. With true market valuations, comparisons can be made to how key asset classes devalued historically to better determine the amount of insolvency risk you have.

4. Analyze the results and identify areas where you can improve. Stay on top of your numbers as future cycles and trends develop in agriculture. Several consulting companies offer financial benchmarking, peer groups, coaching and many other tools.

Study: Solvency trends for Illinois grain farms.

What’s your risk tolerance?

The study above measures solvency and debt-to-asset trends for Illinois grain farms. Equity-to-assets is another measure for what share of the business you own. According to the scorecard, a strong E-to-A ratio is greater than 75% while a weak ratio is less than 40%.

Using conservative asset valuations could skew these numbers and give an inaccurate picture. For example, if your balance sheet shows $5 million of equity and $10 million of total assets, this indicates you own 50% of your business. However, using a true market valuation of your assets could change the numbers to a more representative snapshot of owning 65% to 70% of your business, a much stronger position.

If you are more highly leveraged and own less than 40% of your business, you may want to brainstorm how you can increase profitability, create new sources of cash flow and working capital, pay down debt, or free up some of your equity by liquidating “nice-to-have” assets.

If you are relatively low leveraged and own 80% to 90% of your business, this indicates you could reinvest some of your equity into new opportunities and still maintain a relatively strong financial position. Or you may want to stay the course knowing you’re much better off owning the majority of your business versus the bank.

In either case, as the late business management expert Peter Drucker warned, “You can’t manage what you can’t measure.”

With higher interest rates and strained profitability, Sam says the 90’s mantra of “working capital, working capital, working capital” is fully legitimate again.

Downey has been consulting with farmers, landowners and their advisors for the last 24 years. He is a farm business coach and transition consultant with UnCommon Farms. Reach Mike at [email protected].