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A Financial Physical

November 6, 2009

The silence is killing her. In 1998 when the hog industry was in trouble, people were talking, says Knoxville, Iowa, banker Leslie Miller. Today's livestock situation is even more troubling than it was in then. Aside from livestock, Miller is concerned about the health of the entire industry if the situation continues.

"With most experts predicting we need 500,000 fewer sows, I am concerned about corn demand," Miller says. "If we realize that reduction, that's 110 million bushels of corn that needs somewhere else to go."

Compound the hog situation with expected lower export numbers for 2010 and a severely weakened dairy industry, and the outlook for all commodities is questionable as we move into the next year, she says. With this in mind, she is encouraging all her farm customers to take a financial physical.

Vital Signs. It seems every banker and consultant has a different list for judging financial health. The most common factors are liquidity, solvency and profitability. Miller has these on her list, but she also includes efficiency and the ultimate for bankers: debt repayment capacity.

"In the short run, liquidity is king. Solvency is next," says Iowa State University ag economist Bob Jolly. "Solvency creates a credit reserve­—unused borrowing capacity. If you have a credit reserve and you're going through a period of narrow margins, that gives you something to borrow against."

Jolly likens it to a health physical. A variety of tests are run to paint a clear picture of the patient's health.

"The same is true with assessing financial performance," Jolly says. "You have to understand the profit or income position. If you see your equity grow, is it due to earnings and retained income, or have they just marked up land values? Frankly, a period of high land inflation like we've been through the past few years just hides a world of sins."

Just as is the case with human health, not staying current on financial records and analysis is the number one mistake farmers make, says Fort Atkinson, Wis., banker Dick Horne. Ultimately, a financial physical is done in steps. For Horne, it's a two-step processs and it begins with reviewing the current financial situation—sort of the initial blood pressure, pulse and temperature. He uses 16 key financial ratios.

"This will tell the farmer and banker what the carryover debt is to be termed out over a three- to five-year period," Horne says. "It also gives them the equity position by evaluating the various ratios."

He then moves to overall business profitability. "This includes net farm income, return on equity, return on assets, operating margin and debt repayment capacity," he says.

For all commodities, but particularly for the dairy producers Horne works with, cash-flow estimates are a tricky proposition. This is why he is a proponent of risk management tools to secure some level of confidence in cash flow.

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FEATURED IN: Top Producer - NOVEMBER 2009

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