Good Financial Analysis Starts with a Year-End Balance Sheet

The beginning of a new year marks a time for a fresh start, a new tax year, and sometimes new opportunities. Besides gathering tax information, a good business practice during the first quarter of each year is updating your Year-End balance sheet, dated either December 31 or January 1. In addition to having a copy to give to your lender, there are several other good reasons for having a current year-end balance sheet:
• A consistent year-end balance sheet can be used to analyze and compare your year-over-year progress – how much equity was built or lost
• A year-end balance sheet can be used to accrual adjust tax return income (Schedule F) to what was actually earned during the crop year. Deferred grain
sales, inventory, and prepaid expenses contribute to a significant difference between Schedule F and what actually happened during the year
• The balance sheet can be used to track current solvency and liquidity ratios.
         – Solvency relates to net worth/owner equity. The owner equity percentage is typically defined as owner equity (assets-liabilities) divided by total assets. Net worth should also be tracked yearover-year. Ideally, the producer should aim to have over 50% owner equity in the operation
        – Liquidity is typically measured by working capital. Working capital is defined as current assets (including cash, receivables, inventory) less current liabilities (operating loans, upcoming loan payments, and payables). Ideally working capital should be at least 15% of gross sales
• In addition to fulfilling a lender requirement, there are benefits to tracking the numbers. Having adequate working capital means being able to be in the
driver’s seat and having the ability to take advantage of opportunities. A stronger balance sheet also allows more flexibility in expansion, bringing another
generation into the farming operation, and provides help in determining succession and retirement planning.

By knowing what financial metrics to look at, you will be able to evaluate your operation and uncover any issues. If you monitor them annually, you can also do a trend analysis to make better long-term strategic decisions. Here are several key metrics provided by the Center for Farm Financial Management at the University of Minnesota that you should track.
• Current Ratio: As a measure of liquidity, this ratio shows the extent to which current assets would pay off current liabilities. Calculation: Current Assets ÷
Current Liabilities
• Debt to Asset: As a measure of solvency, the debt-to-asset ratio helps you understand your farm’s financial leverage. Calculation: Total Debt ÷ Total Assets
• Return on Equity: As a measure of profitability, your return on equity shows the performance of your invested capital. Calculation: Net Farm Income – Family Living ÷ Average Farm Equity
• Asset Turnover: As a measure of financial efficiency, this ratio shows how effectively you are using assets to generate revenue. Calculation: Gross Revenue ÷
Assets
• Term Debt and Capital Lease Coverage Ratio: As a measure of repayment capacity, this ratio shows if you can pay your intermediate and long-term debts on time. Calculation: [Net Farm Income + Non-Farm Income + Depreciation – Taxes – Family Living] ÷ Principal and Interest Payments on Term Loans and Capital Leases.

The ratios above are only five of the 21 financial ratios that the University of Minnesota suggests you monitor. For a full list, go to: https://www.cffm.umn.edu/wp-content/uploads/2019/02/FarmFinanceScorecard.pdf

Feel free to contact any of the AgQuest Business Relationship Managers for questions or more details: Call 877-626-74453 or click here to locate your local BRM.

Central Farm ServiceACCentraSotaCrystalFarmwardGreatHeartSeedLocalSeedUFCUnitedPrairie