The other day, I was at a banking school when one of the co-instructors, who is a banker, made a profound comment. He stated, “Successful producers take ownership of their numbers.” I absolutely agree with this statement! The financial statements can be a great communication tool between producers and lenders.
Many producers only examine their financials once per year for tax purposes, also known as “drive-by” financials. The successful lenders and producers in a side-by-side relationship will systematically examine the financial statements at least once per quarter, if not more. This examination will include an up-to-date analysis of cash flow and comparing projections to actual results. In addition, a three- to five-year trend analysis can provide a view of which direction the business is going financially. When examining the financial statements, the reasons for abnormal performance can be a means for discussion and dialogue not only with the lender, but business partners, spouses, and management team members.
I am constantly stressing to lenders, specifically new lenders, to convert their conversations into “customer speak,” rather than “lender speak.” While lenders will use the current ratio to examine financial liquidity, a more communicative metric is working capital to expenses or working capital to revenue. The producer can understand that 20 percent of working capital to expenses means that at that moment the business can generate 20 percent of expenses through internal working capital and the remaining 80 percent must come from other sources such as a lender or the liquidation of long-term assets. Similarly, lenders will use the debt to equity ratio to explain financial leverage on the balance sheet. While an acceptable metric internally, the debt to asset ratio, equity to asset ratio, or percent equity simply illustrate to the customer the percent of the business owned by the owner versus funded by debt.
Another method of communication is using family living withdrawals to conduct an earned net worth analysis. Take the beginning balance sheet net worth and add the after-tax profits to calculate the ending balance sheet net worth. In some cases, large discrepancies will occur and many of these situations can be linked to withdrawals from the business for family living expenses or the purchase of unproductive assets and/or non-farm investments such as killer toys.
The examination of financial statements can be a great equalizer in communications in working externally with the lender, accountant, or transition management team. Internally, the financial statements can be a great tool for discussion amongst partners, spouses, and equity stakeholders and can display the current and future direction of the business.
The key to success is to conduct this exercise regularly, engage, and focus on financial performance rather than being distracted by all of the technology and uncontrollable events that are in the news these days.
The opinions of Dr. David Kohl are not necessarily those of Corn and Soybean Digest or Farm Progress.
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