One of my favorite assignments with Farm Credit is conducting young and beginning producer institutes. I feed off the energy emitted from these optimistic, goal-oriented, lifelong learners who are mapping out their journey in their new agricultural businesses and family lives. The investment made by many associations in these lifelong learners who are attempting to become better managers truly will pay dividends into the future of the agricultural industry.
An individual at a recent event asked me an intriguing question. Could you give us a quick primer on financial preparation for our ag lender? While the following tips were discussed for young producers, they are applicable to mature businesses as well. Here are some pointers to help you build confidence in your business financial decision making, which can increase your lender’s confidence in loaning you money.
It is important for each producer, their spouse, and business partners to check their credit reports and scores annually. A 700 score will in most cases be seen as a positive attribute, while less than 650 reflects negatively on you. How do you improve your credit score? Pay your bills on time, maintain a balance of no more than 15 to 20 percent of the maximum limit on your credit cards, and have no more than three to five credit cards.
Each year, develop a balance sheet that reports reasonable values on all assets and liabilities. Your lender can provide guidance on agricultural asset values. Lenders like to see a positive trend in equity on the balance sheet in the form of earned net worth, or retained earnings, rather than inflated asset values. Separate business and personal assets to measure performance accurately for each. Many lenders require a personal and a business balance sheet.
Your lender will ask for several years of tax returns to verify revenue, expenses and the legality of your operation. However, tax returns on a cash basis are a poor indicator of business performance because of income and expense manipulation as a tax minimization strategy. Some studies indicate that there can be up to a 60 percent difference between cash or tax return analysis and accrual-adjusted analysis. Ask your lender to assist you in preparing an accrual-adjusted income statement utilizing the beginning and end of period balance sheets and adjusting for changes in inventory, receivables, prepaid expenses, accounts payable and accrued expenses. Remember that very few farm businesses go broke paying income taxes, but many do go broke trying to minimize income taxes.
Your lender will ask you to submit your best estimates of cash revenue and expenses for the year. Depending on your business enterprise, revenue will be received and expenses paid either monthly, quarterly or annually. Your lender can use a cash flow projection to determine how to best structure an operating line of credit. Putting together a cash flow statement is a good start for your business plan because it requires you to think through your operational plans and numbers.
Lenders like to see three to five cash flow scenarios based upon adjustments to prices, costs, production and marketing assumptions. The key is to examine the bottom line results and strategize changes that you will make in your business game plan with various outcomes.
Many operate diversified multiple enterprise operations. Breaking down each enterprise into a separate budget allows one to ascertain which enterprises are making and losing money so resources can be allocated to profitable endeavors.
Resource Documentation and Commitment
Many young farmers earn W-2 or Schedule C off-farm income to supplement the agriculture operation in the startup or the growing periods. Be prepared to discuss with your lender how much off-farm income you expect to make and how long this commitment will last, particularly if a spouse or business partner is providing financial, labor and moral support.
While few lenders say they receive written business plans, if you complete the preceding steps I have outlined, you are about 80 percent of the way to having a business plan. In your business plan, put your short-term and long-term goals in writing and outline production, marketing and financial targets. For ongoing businesses, document and update a list of accomplishments to measure your progress.
Business plan preparation is great, but now you must “walk the talk.” Your ability to follow through and execute the plan with a minimum amount of surprises and open communication with your lender is critical in taking your business to the high-stakes field of domestic and global agricultural economics.
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