Ten Questions for Renewal Season

Ten Questions for Renewal Season

Review Year End Financials To Prepare For the Coming Year

This year is quickly coming to an end and renewal season for operating lines of credit is becoming a high priority for both producers and lenders. The review of the yearend financials requires a focused examination as one prepares for the coming year filled with market uncertainty and inflated costs. Let's examine some areas of focus that require critical questions for crucial conversations.

Income Statement

Let's start with the income statement. What percent of net farm income was a result of checks from the government? The FINBIN database, managed by the University of Minnesota’s Center for Farm Financial Management, can provide some interesting peer analysis. In the year 2020, farms were broken down by enterprises. Analysis of crop farms finds that 62 percent of net farm income resulted from a government check. For dairy farms, 72 percent of net farm income was from government support payments. Moving to hog and beef farms, the percent of net farm income from government checks was 127 and 108 percent, respectively. The hog and beef farms in the analysis would have had negative net farm income if it was not for the government payments.

Government Payments

Next, take a step further and dig deeper into the government payments. What percent of the government payments were recurring versus non-recurring? For example, conservation payments may be a result of multiple year contracts. However, the Coronavirus Food Assistance Program (CFAP) payments are an example of nonrecurring payments.

Export Markets

Both producers and lenders need to analyze the enterprise concerning its exposure to changes in export markets. Trade deals with China are ending. There appears to be a lack of emphasis on agriculture trade, which can impact net farm income generated from export markets. Geopolitical and military tensions, along with trade deals, can change outcomes in the next few years. Couple this with inflated costs and managers must analyze the business both from a revenue and a cost standpoint.

Business Profitability

If the business is profitable, how were the positive returns generated and were they measured on an accrual basis? What percent of the net farm income came from government payments or following a marketing and risk management program? Did the income come from speculative marketing, or did it result from a balanced program of production, marketing, financial, and operational efficiency? How important were outside revenues on the cash flow’s bottom line?

Profit Distribution and Investments

Next in the analysis, how were the profits distributed and invested? Assess if profits were used to build working capital levels or were they spent on family living expenses or dividends? Be careful of the tax bill surprises and obligations if the business was profitable. Careful analysis needs to occur on whether investments were made in intermediate and long-term assets. How much additional debt service obligations were incurred, and will obligations be able to be met with a possible reduction in government payments?

Supply and Marketing Chain Disruptions

An increasingly important analysis is the vulnerability of the farm or ranch to supply and marketing chain disruptions. In this analysis an assessment of processing, integrators, and/or contracts needs to be conducted for potential risk.

The Balance Sheet

Moving to the balance sheet, an analysis of working capital lines of credit needs to be a priority. Did they increase, decrease, or remain the same? Next year, with tighter margins and inflated input costs, expect the balance outstanding on working capital lines of credit to increase. Referring to the FINBIN database, working capital to revenue for the top 40 percent of producers was nearly 44 percent. For the bottom 40 percent, the ratio was slightly over 15 percent. This area of the financial statement needs to be a high priority over the next few years.

Earned and Appreciated Net Worth

Moving to the bottom segment of the balance sheet, an analysis of earned and appreciated net worth needs to be conducted. Over the past five years, the top producers generated about 75 percent earned net worth versus 25 percent appreciation. The bottom 25 percent of producers generated 25 percent earned net worth versus 75 percent resulting from appreciation. The bottom line is that you need to know what portion of net worth is from good old-fashioned retained earnings and what is a result of a change in set values on the balance sheet.

Looking Ahead

The next area of analysis concerns the long game. Many farmers and ranchers are purchasing land or expanding operations for the next generation. The key question is whether there is a transition plan and estate plan in place that are being executed and monitored. Lack of a transition plan is potentially an Achilles' heel for all generations involved in the business.

Business IQ

In previous articles, the business IQ chart was introduced. First, are both the customer and lender willing to fill out the business IQ assessment? Next, have you identified what you do well and what you would like to continue? Identify three areas for improvement and use this tool for incremental improvement. Peer comparisons will find a score of 32 as a median; however, the key is having an attitude for proactive progress. Remember, business improvement starts from the inside out, not the outside in.

These are 10 areas of focus that could put the odds on your side in an era of extreme volatility and macroeconomic uncertainty