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Financial hotspots: What's on your farm business balance sheet?

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Check in on your business working capital, expenses, debt service and more.

The last column was devoted to examining hotspots on the income statement. The analysis included how profits were generated and distributed. Our discussion focused on how the income statement may have to be tweaked, given the storm clouds of inflation, trade uncertainty and everything else under the sun coming at us in 2022. Now, let's focus on the balance sheet and zero in on some of the critical hotspots.

In recent discussions with agriculture lenders, they have indicated that credit lines have been paid down and working capital positions are the best among stronger managers. With that being said, take stock of your working capital position. Lenders often utilize the current ratio. Given that we are at the top of the economic cycle, they will seek a current ratio of at least 1.5 to 1. To meet this benchmark, you must have at least 1.5 dollars of current assets for every 1 dollar of current liabilities.

A more practical ratio is working capital to total farm expenses. If this metric is utilized, a strong working capital position would be greater than 25 percent of total expenses. Some analysts like to see it between 30 and 40 percent in the top of the economic cycle. If the business has been profitable, then this ratio should be ascending. Next in the analysis, examine what percent of the working capital can be turned into cash in a 90- to 120-day cycle.

In your balance sheet analysis, determine the direction of accounts payable. Many agribusinesses that I visited have stated that strong managers are paying down these obligations.

A new metric that is being utilized is to divide principal and interest payments, or total debt service, into working capital. If the number is greater than 3-5:1, your business is in a good position to meet debt service obligations, which are an overhead cost.

Finally, what is the trend in net worth? With land inflation, appreciated net worth is being observed on many farm balance sheets. The true picture of net worth gains is earned net worth, which is a measure of what profits made it to the balance sheet as retained earnings after living costs, withdrawals, taxes and dividends. This metric is often used to evaluate a business owner’s and managers ability to build wealth the good, old-fashioned way through earnings and sacrifice.

The last two columns will get you started on discussions and critical thinking with a focus on the financials. I suggest that you save the date on your calendar in late January to attend the Farm Futures Business Summit and Ag Finance Boot Camp to drill down on some of the more specific financial metrics.

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