Successful farmers display certain financial habits that separate them from others. These habits, consistently applied through the years, add up and the results are evident.
Having the proper amount and type of liquidity is No. 1 on the list of effective financial habits. If you fail on this one, the others don’t matter. On a farm, cash and other liquid financial assets keep the operation running smoothly. Improve your liquidity by taking advantage of low interest rates and growing right.
"Having the proper
amount and type of
liquidity is No. 1
on the list of effective
Build Liquidity. If purchasing equipment reduces liquidity below optimal levels, consider taking on debt, especially with today’s low interest rates. To keep your banker happy, maintain a conservative lifestyle. The more cash that is retained in the business and not used to fund off-farm lifestyle, the more liquidity you build. When looking to grow, it might make more sense to add a circle around the acres you own or rent than to pay $400 cash rent for a neighbor’s quarter section. The circle would generate extra income per acre exceeding the cost to finance, whereas the additional cash rent might barely cover your crop margin and the upfront payment would reduce liquidity.
Use Accrual Accounting. The only way to know your true net farm income is by accrual accounting. Your banker is already spreading your numbers using some form of the accrual process. Learn it and use it. Several accounting packages are available and with a few steps, it can easily convert to cash for your tax preparation.
Put a Value on Your Time. Many clients ask me the worth of their business. Too often, I report that it’s essentially worth zero. The typical reply is, "How can that be? My net income is $75,000." But your net income does not reflect the cost of your spending 3,000-plus hours to run the business each year, and replacing you would cost more than $75,000. Financially effective farmers understand that the farm must compensate them for their time and provide a bottom-line profit. Their profit is not their compensation, but rather what remains.
Know Opportunity Costs. If you pay $350,000 for a combine but use it only five weeks each year, what is the opportunity cost of having it idle? Consider renting, doing a three-year lease or time-sharing it with farmers in other parts of the U.S. with different harvest times. Even if you pay cash, what profits are you passing up versus the value derived from the machine? This difference is your opportunity cost. You need to know it on all major purchases and investment decisions.
Pay Taxes. Most farmers resist paying income taxes. They get on the treadmill of prepaying crop input costs, buying equipment and deferring sales to future years. Financially astute farmers determine the optimal level of taxes, which incorporates an estimate of current and future tax liabilities and the effect on their liquidity. These farmers track the estimated total deferred taxes due in future years, which is a liability and virtually inescapable. Once paid, these after-tax funds provide liquidity to the farm operation. Not paying taxes slowly but surely sucks liquidity out of the farm, and in many cases the farmer’s marketing efforts suffer since the tax tail is wagging the marketing dog.
Join a Peer Group. Effective farmers are very competitive. By joining a peer group, you can make this competitiveness work for you. The farmer who has taken care of nine items on a 10-item list will spend the most time on that tenth item. A peer group will help you focus on and strengthen your weaknesses.
If your farm operation utilizes all of these habits, congratulations. However, if you are weak in one or more areas, pick one to work on and re-evaluate after six months. You might be surprised by how much it helps your operation. Now is the time to get better!
Paul Neiffer is a tax accountant with CliftonLarsonAllen and author of the blog The Farm CPA. He grew up on a wheat farm in Washington and owns a corn and soybean farm in Missouri. Contact him at email@example.com.
- January 2013