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Managing profit: Avoid tension with this farm policy

Getty/iStockphoto money bag field
Here’s a helpful guide on how to invest higher-than-average farm profits.

2021 was a profitable year for many farms. Seeing a higher-than-normal number on the bottom line has prompted some family discussions on how to use the money.

Your answer likely depends on the financial situation of your farm. If you’re at higher-than-desired debt levels, the decision to pay down debt may be the most obvious answer. You’re likely budgeting for more working capital, planning around the current volatility (and possibly more to come, beyond high input costs). 

So what are some other ways to manage money after a profitable year like 2021?

Some owners may desire increased distributions. I’ve seen differing philosophies on whether we should enjoy the good years, conservatively stockpile for the worst case, or reinvest in more land or equipment.

All those decisions around “extra” profit in good years could lead to some tension. As a solution, I suggest you define a standing policy about how distributions are prioritized every year. Having that in place helps remove the debate in the future and contributes to a healthy partnership.  

Your policy might have tiers or tranches of net income allocation (after debt is covered). These could be a combination of dollar amounts or percentages of net profit. For example, 

  1. Living expenses (salary) distributions are taken as agreed throughout the year. 
  1. We pay down debt to predetermined debt/equity goals. 
  1. X is retained for working capital ($/acre). 
  1. The next X of profit goes to “extra” distributions. In good times, we all benefit some more. 
  1. The next X of profit is retained for growth or further debt reduction, specifics to be decided by the partners. 

A variation of this is that a minimum X% of net profit will be paid out as distributions after working capital needs are reserved. Your financial advisor, accountant, or banker can help you design a rule of thumb that works for your situation. The partners can agree to deviate from this plan with a unanimous vote (or requirement from lenders in some unusual situation), but pending agreement, this is the default. 

Up next: Managing profit: Have a talk before you add new business ventures

Davon Cook is a family business consultant at K Coe Isom. Reach Davon at [email protected]. The opinions of the author are not necessarily those of Farm Futures or Farm Progress.  

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