Business Matters: The Value of Financial Simplicity

November 25, 2015 02:52 AM
 
Business Matters: The Value of Financial Simplicity

As we get close to the end of the year, there are lists of things we need to finish up on the farm, not to mention all of the activities during the holiday season. Without question, you should make time with family and friends a top priority.  

On the farm, it’s time to transition into the office.  A big portion of year-end financial success depends on your commitment to measuring your situation accurately. For many of us in agriculture, the office and financial work isn’t the factor that originally brought us to this career. Yet if we don’t commit sufficient time to measuring, documenting and scrutinizing results, it could be the factor that takes us out of this career. 

Most producers tend to have good-quality cash accounting, including basic ratios and a balance sheet with depreciated tax values on facilities and equipment, yet it’s totally misleading and inadequate for understanding your true financial position. 

Emphasize Earned Equity. Many best-in-class farm operations are extremely sophisticated. They measure their business with cash, accrual and even managerial accounting. Yet more information doesn’t necessarily lead to a better understanding of your farm. 

The most important thing is that you understand your financial situation. If you can’t explain it, you don’t understand it. Simplify your information.

A complete financial year-end report of your operation is a necessity. Yet there is one number in particular that can provide a clear picture of your annual success. Known as earned equity, it describes money earned during the fiscal year and retained within the business entity. 

To accurately pinpoint this number, consider several factors. First of all, complete an annual market value balance sheet. It’s an absolute necessity. The next critical component is to achieve consistency in year-over-year reporting. Values for facilities, equipment, inventories and prepays should be determined with the same formulas and at the same time every year. 

Visualize Your Finances. It’s an absolute necessity to keep each year’s income and expenses isolated to the particular year in which an income or expense occurred. One way to make sure numbers are accurate is to utilize a good cost-of-production tool for each profit center within your operation. No matter how careful you are in keeping this information as perfect as possible, some situations will require a certain degree of subjectivity. The bottom line is to be consistent in how you come up with numbers year over year. 

The chart below illustrates the value of measuring earned equity year over year. As you establish consistency in measurement, use tools to evaluate your 10-year financial trends. Sometimes, the simplest numbers can illustrate more about an operation than the most complex ratios.

Lenders will continue to increase scrutiny of our financial health and analysis, especially as the need for working capital increases over the next few years. This type of comprehensive yet simple information will be necessary to assure our lenders we are trending in the right direction. 

Measure Operational Health Over Time
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Use charts such as this one to understand your farm’s financial health over time. This table illustrates a farm experiencing positive growth. For example, the operation saw asset gains from 2011 to 2015. It had equity increases beginning in 2012 and continuing through 2015. 

 

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