As a young farmer growing your farm operation, you may find yourself facing many challenges in today’s financial climate: current commodity prices, rising interest rates, and uncertain growing conditions all can provide financial stress to a beginning farm operation. Finding a lender that is willing to work with your operation as a financial partner is critical to the success of your operation no matter how large or small it may be. Fortunately, there are a few key steps and business practices you can implement to ensure the longevity of your operation and its future success.
1. Understand and manage your margins
Margin is the income leftover after you have accounted for all debt service, taxes, and family living expenses. The higher the margin, the better. Monitoring your margins will allow you to better analyze future capital purchases, farm cash flows, and your family living budget. Margins affect nearly every business decision you make, and prior to any major investment or purchase, an adequate margin must be present to allow a cushion for any short- or long-term risks.
If you haven’t done so already, now is the time to sit down with your lender to create and review your financial statements. Annual financial statements, including balance sheets, income statements, and cash flow statements, provide not only your available margins, but offer an overall snapshot of your operation’s financial position. Completing these statements with your lender allows you to be proactive in any discussions regarding additional credit, and gives you their perspective on the operation’s financial health.
When assessing your current margins, focus on a couple important areas. First, determine your current debt obligations, including current portion of term debt and interest on term debt. Ensuring your term debt levels are in line with the size of your operation is key. If they are not, it may be prudent to retire or restructure any term notes that negatively impact this measure.
Second, pay special attention to your family expenditures. Any personal debt you take on, including mortgages and car loans, affects the bottom line of your business and should be carefully weighed as non-income-producing assets.
Finally, be mindful of the cash burn rate or cash build rate of your operation. Cash burn or build rate most simply refers to your operation’s ability in the next fiscal year to conduct business at a cash flow deficit or cash flow build. This measure directly impacts your working capital position, and adequate forms of working capital should be present if there is a deficit. In years of declining crop prices, this measure is especially important to evaluate as it can be the first indication of financial stress in the coming year.
In years of cash flow deficits three things can be done to mitigate any negative effects:
• Control fixed costs, including land, buildings, equipment, employees, family living expenses, and taxes.
• Rethink liquidity. Monitor your working capital position and how current loan structures, down payments on real estate, and equipment purchases impact this measure.
• Line up operating financing now. Starting conversations with your lender early on in the season allows your operating needs to best align with the operation’s needs, and allows your business to secure opportunities for discounted inputs as they arise.
2. Write a business plan every year
The effectiveness of physically writing down personal goals is undeniable. The same holds true for your business: Commit to writing an annual business plan every year.
The beginning of a new year is an ideal time to assess your learnings from the previous year’s expenses to build out a projection for the year ahead. Look at your net income versus your net expenses from the past year and consider the crop or livestock plans you have in mind. Using this assessment, make an informed estimate based on what you know and predict if your revenue will increase or decrease.
Once you have a projection in place, you can then evaluate how this revenue will impact your operational goals and balance sheet. Ask yourself a few questions:
• Can you invest in your operation?
• Do you need to make cuts anywhere?
• Is your asset list adequate for your operation’s success?
Document your plan for any investments or necessary expenditure reductions, and regularly revisit it throughout the year to keep the business on track or to make necessary adjustments as any unforeseen circumstances occur. Farm Credit officers are available to help you through the entire business planning process and analyze and assess year-to-year progress. Our programming created specifically for young farmers is designed to pair you with a team of specially-trained credit analysts who understand beginning farmers and their specific needs.
3. Understand the purpose of your operating loan
Operating loans are designed to get you and your operation the cash you need, when you need it. Align your operating note with the cash flow of your business. For a row crop operation, this means utilizing the operating loan when input costs arise, and paying down the note upon sale of the crops. With livestock, consider the lifespan of the animal. Budget notes based upon the income and expenses of livestock turns allows you to better monitor your break-evens.
Overall, utilize the operating note for its true purpose: financing inputs during a crop or livestock production cycle. This line of credit is not intended for long-term investments like buying land or additional equipment. If you are interested in purchasing land or upgrading equipment, talk to your lender about credit options with longer repayment terms designed for business investment purposes.
It is important to align your operating loan with your working capital or you can be turned upside down quickly. If your business has suffered from net operating losses, you may have money sitting on your operating note that you cannot fully revolve, or frozen operating debt. If you have taken out an operating loan in the past and find yourself with frozen operating debt or potential losses, work with your lender to resolve the issue. Farm Credit works with farmers in similar situations every day and can help develop a flexible strategy for your unique situation.
Financial success takes planning and consistent business practices. By taking proactive steps to understand your margins, create an annual written business plan and understand the best use of an operating line of credit, you can set your operation, your family and yourself up for a viable future.
For additional commentary and perspective on trends affecting ag finance click here and download the Farm Credit Mid-America Insights Report.
- Jessica Lehman is associate vice president, business segments, Growing Forward | Farm Credit Mid-America