September 12, 2019

Prepare Your Finances For 2020

 |  By: Anna-Lisa Laca

For the first time in several years, most farmers are operating at profitable levels. Given the current geopolitical climate, there is no telling how long this price rally will last. Bankers and analysts alike agree that producers should use this time to prepare their finances for 2020. 

Analyze Your Balance Sheet 

Nobody likes surprises, especially your lender. According to Curt Covington Executive Vice President of Farmer Mac, farmers and some lenders place too much focus on the income statement and too little focus on the balance sheet. 

Here are four steps to bullet-proof your balance sheet: 

Focus on the things that matter. Operating lenders view working capital as the borrower’s “skin in the game,” Covington says. Lenders expect a shared risk arrangement with their borrower. “No lender wants to finance 100% of the borrower’s expenses,” he explains. “A strong working capital position communicates to the lender the borrower is willing to put their money where their mouth is.”

Be conscious of financial statement leverage. “Money that is borrowed in good times has to be repaid during the bad times,” Covington says. 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.

Think long term. Farming is not a get-rich-quick business. Extraordinary profits in one year can certainly be given back the next. 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. Equity in your farming business grows as profits grow, Covington says. If working capital is the first defense against commodity price volatility, equity is the long-term buffer against insolvency and bankruptcy.

Read more of Covington’s advice, here.

Prepare Your Loan Request

As loan request and renewal season approaches, it’s important to understand what needs to be included in your loan request application. According to Peter Martin of KCOE ISOM, it’s important to submit a written document with your loan request. “A written record minimizes the chance of mistakes creeping into the process as your loan request moves from one person to the next,” he says. “It gives you more control of the process, shows professionalism and can make a positive difference if your lender is on the fence about approving your request.”

A good loan-request outline covers these four key areas that tell your lender about yourself and your operation:

  • The purpose of request is a single paragraph explaining what the requested funds will be used for.
  • A management analysis which outlines your farm’s background, ownership structure and management overview.
  • The financial analysis focuses on numbers for at least the previous 12 months as well as going forward.
  • A guarantor analysis explains your ability to guarantee the debt payment.

Read more from Peter Martin, here.

Replenish Working Capital

With milk prices still at profitable levels, now is the time to start thinking about replenishing your working capital. Shoot for at least $400 of working capital per cow—$600 is even better. 

“I also like to divide working capital into annual expenses,” Dave Kohl, an emeritus economist with Virginia Tech University, says. “Once it’s above 25 to 33%, you’re pretty strong. But if the ratio starts getting less than 10% of your expenses, you’re going to have to be very careful that you don’t burn through your secondary reserve.”

That’s particularly true if you refinance to extend loans in order to lower monthly payments, he says. Once you do that, your margin for error becomes less because you have less equity in cattle, buildings and land to fall back on if you continue to have cash flow problems.

For detailed steps on how to replenish working capital, go here.