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Producers need to know their financial position better than anyone. Much like looking for machinery breakdowns when completing morning maintenance, or examining crops for the latest pests, potential problems can be avoided and corrected by understanding our finances.
A financial statement should be prepared and completed annually by December 31st. Preparing a financial statement at the same time each year provides a year-over-year comparison of your operation. Compare previous statements to determine areas of improvement or decline. If you find areas of decline, address the issues immediately.
What does a financial statement tell us about our financial health? Let’s start by reviewing a basic financial statement, understanding a few key financial ratios, and terminology.
The financial statement should be divided into three sections:
Intermediate Assets and Intermediate Liabilities
Long-Term Assets and Long-Term Liabilities
Net Worth is the difference between these assets and liabilities.
Once you complete your financial statement you can determine the health and the future of your operation.
Understanding assets and liabilities
Consider the Current Assets and Current Liabilities section of the balance sheet as the eyes of your operation. Much like walking through a set of newly weaned calves or planted fields, you are looking for potential problems and addressing those problems before they become serious. This is your first line of defense to maintain financial health. It is a look into the future, letting you know if you are going to have ample cash or experience cash flow problems in the short term.
Current Assets/Current Liabilities provides a current ratio of liquidity. For example:
Current Assets $1,200,000 ÷
Current Liabilities $850,000
This ratio indicates that you have 41 cents more assets than you do liabilities.
KOHL’S FINANCIAL RATIOS
1.00 – 1.49: RESILIENT
Your operation can withstand longer periods of economic adversity. You can make immediate changes as needs arise. You will be able to finance some of your own operating expenses or pay for small capital purchases.
Your operation can withstand shorter periods of economic adversity. Producers need to maximize revenue, monitor and reduce operational expenses, and slow short-term, intermediate and long-term purchases. You may need to amortize debt carried over from previous years or amortize assets that have been purchased on your line of credit. Look at excessive family living expenses. Review enterprises that are not performing and make changes. Review cash flow. Discuss your financial position with your lender, accountant, and trusted advisors.
Producers should pay immediate attention to their financial situation. You need to seek immediate advice from your lender, accountant, and trusted advisors. Amortize carry-over debt and assets purchased or placed on your line; look closely at changes that need to be made to your operations to increase production; control operational expenses; review your cash flow and budget; discontinue enterprises that are negatively impacting your cash flow. Remove excessive living expenses and look for outside sources of revenue. Do you have assets not in use that can be sold to generate cash or reduce debt?
Current Assets – Current Liabilities is your working capital, providing information on cash available to your operation above your current liabilities. In other words, excess cash. For example:
Current Assets $1,200,000 –
Current Liabilities $850,000
= $350,000 in working capital
Look at this as your cushion. This is what will protect you in case of any unseen need for cash above your available line of credit. It is also the money that you have available to operate on your own without using your line of credit, or make payments and pay down debt. The more working capital, the greater the safety net for your operation.
The next key ratio to look at is the Debt to Asset Ratio. If the Current Ratio is the eyes to your operation, the Debt to Asset Ratio is the heart beat. The Debt to Asset Ratio is a measure of solvency. Meaning, will your operation withstand time and economic adversity?
The Debt/Asset Ratio is the ratio of solvency. For example:
Total Debt $1,325,000 ÷
Total Assets $3,225,000
This ratio indicates that you have debt of 41 cents on every asset that you own.
KOHL’S FINANCIAL RATIOS
.40:1 – 0.70:1: RESILIENT
Your operation could withstand longer periods of economic adversity. A ratio at this level may allow you to expand your operation, update equipment, or purchase land with less risk.
You may withstand short periods of economic adversity. At lower levels, you may be able to do small expansions and capital purchases. At higher levels you may want to start liquidating non-earning assets or assets that are not producing at desired levels of income. Review enterprises that are not making money and liquidate or stop operating those enterprises. Discuss your financial position with lender, accountant, and trusted advisors.
Your operation may be at risk of failure. It is time to take a hard look at your overall operation and determine what major changes need to be made to restore financial solvency. What assets can be liquidated and applied to debt reduction? Ask yourself: What is the viability of my operation? What will my operation look like in the future after some form of liquidation to reduce debt? You will need to seek immediate advice from your lender, accountant, and trusted advisors.
As you review your balance sheet, make sure it is properly structured. Are short-term assets financed with short-term debt, intermediate assets financed with intermediate debt, and long-term assets financed with long-term debt? If your assets are not financed in the proper category, begin the steps to properly structure the debt.
Our ag bankers don't just know banking - they understand the needs, challenges, and hard work involved in running a successful agribusiness. If you’re ready to add to your team of financial partners, contact us today.
Stay Tuned: Upcoming articles will discuss net worth, earned net worth, cash flow and debt service coverage.