bank building
August 19, 2016

Mind Your Balance Sheet

 |  By: Curt Covington

Curt will be sharing his best banking insight and annual outlook for the financing market at the 2016 MILK Business Conference in Las Vegas Nov. 7-9. For more information and to register for the conference please visit the events section of our website, here. Join your peers at the best business conference in the dairy industry.

Nobody likes surprises, especially your lender. Farmers (and frankly, some lenders) place too much focus on the income statement and too little focus on the balance sheet. Here are some concrete and common-sense steps farmers can take to insure their balance sheet is “battle-ready” for the tougher times ahead.

Focus on the things that matter. Operating lenders view working capital as the borrower’s “skin in the game.” Lenders expect a shared risk arrangement with their borrower. No lender wants to be put into a position where they are financing 100% of the borrower’s expenses. A strong working capital position communicates to the lender the borrower is willing to put their money where their mouth is. A borrower who squanders his working capital on unnecessary capital expenditures and a fancy lifestyle is sending the absolute wrong message to his lender. Look at it this way, your financial statement is your company’s written form of communication to the lender. Don’t send the wrong message. In almost all cases, more working capital is better. Working capital has always been the first defense against commodity price volatility.

Be conscious of financial statement leverage. Ever heard the saying, “Speed kills?” For farmers, leverage kills! Leverage (or debt), is every farmer’s friend during prosperous times. Operating, equipment and real estate debt payments are easy to get and easy pay back during good times but remember, those same debt payments don’t go away during tough times and can overwhelm the business before you know it. As an ag lender with almost 40 years under by belt, one of my favorite sayings is, “Money that is borrowed in good times has to be repaid during the bad times.” How true.

Think long term. Farming is not a get-rich-quick business. Extraordinary profits in one year can certainly be given back the next. In fact, there is good evidence in some sectors of agriculture to suggest that one year of losses can take two years or more of normal profits to recover. Weighing down the balance sheet with too much debt that, again, does not go away during tough times can sink any business.

It’s equity, not assets, that matter. If you asked a business person what they are “worth,” you might be surprised by the answer. Many measure their worth by the assets they own. Unless their business is absolutely debt free that answer is incorrect. An owner’s worth or equity is measured by the portion of those assets that are debt-free. For example, if a farmer has an asset value of $1 million, yet owes the bank $600,000 on a mortgage note, his worth is $400,000—the difference between what he owns and what he owes. Why do I make this illustration? Because it is the equity that matters in the end. Equity in your farming business grows as profits grow. If working capital is the first defense against commodity price volatility, equity is the long-term buffer against insolvency and bankruptcy.

I don’t claim to know the absolute right metrics for every farmer’s balance sheet. However, it doesn’t take a graduate degree to know tough times on the farm will eventually impact the business. Get your mind set on protecting your balance sheet for the battle ahead.