The experience of the 1980s farm debt crisis pointed out that the methods used to determine,
measure and analyze the financial position and the financial performance of farmers were
either totally inadequate or seriously underutilized. Today, as profits look more challenging to attain in 2014, financial institutions are starting to push for strong accounting principles and adoption of GAAP (Generally Accepted Accounting Practices).
"Banks are starting to force this," says Thomas Bayer, CPA, Partner with Sikich LLP. "If you want to move upstream with your banking relationship, you are required to have GAAP financial statements. That’s the new rules of the game once you hit a certain number you need for credit to operate."
Sikich spoke at the 2014 Top Producer Seminar today in Chicago.
"Most farmers prepare a balance sheet and owner equity calculations based on market value rather than historical cost or other valuation methods," notes Bayer.
(Click here to see the full coverage of the Top Producer Seminar.)
The Farm Financial Standards Council (FFSC) recommends farmers begin to move from cash based accounting to GAAP because of: (a) the lender’s need to determine the reasonableness of
collateral values; (b) the lack of records to track and accumulate historical costs; (c) the hybrid
nature (personal and business) of many farm financial statements; and (d) the dramatic increase
in investment in capital assets during a period of time when the value of these assets was
appreciating substantially, causing the true value of these assets to bear little resemblance to
their historical cost, adjusted for depreciation.
"All of those issues will play into concerns over whether a lender says yes,"’ Bayer says. "The lender knows you have a lot of equity, but they need to see financials on a consistent basis so they can compare you to others."
GAAP also helps farmers as they get bigger understand their own financial position. "You can’t do that unless you have this common reporting language you use from year to year," he says. "Also it gives you credibility."
It builds credibility with:
- Major vendors and inputs suppliers
- Customers that buy your grain
- Investors to help fund land
"Most of all – its better information for the owners and management team," Bayer says. A University of Illinois study comparing accrual basis operating statements using GAAP to tax reporting based information saw an average annual difference of 59%. This affects your ratio, Bayer says.
There are several issues that can arise, however, when you convert to GAAP basis financial statements. An accurate operating statement for a period is dependent on accurate beginning balances for grain inventory, input inventory, any open purchase and sales contracts and equipment capitalization. "We recommend going through the experience of preparing a balance sheet one year before GAAP basis financial statements will be required," Bayer says.