What should your balance sheet look like?
August 12, 2013
Most farmers and ranchers often start their career with very little, often nothing more than an old pickup, a strong back and good work ethic. Their beginning balance sheet reflects this and does not take long to fill out. Once they have been in the business for a number of years, the question becomes "what should their balance sheet look like?"
Unfortunately, there is no template out there that tells you exactly what your financials should look like if you are a 27-year-old grain farmer in East River South Dakota or a 36-year-old rancher in West River South Dakota. So what should a balance sheet look like?
First off, I would say…improving! A lot of farmers and ranchers who made it through the 80's will say their primary goal each year is survival and others more recently would tell you minimizing income tax expense is their goal, but I would say that it should be to make money and improve their financial position. One result of making money is obviously paying income tax, which needs to be managed, but not avoided. Being profitable on the farm is necessary to continue to improve your equity position on your balance sheet by paying down debt and making capital purchases.
Secondly, I would say proper structure is very important. Farmers can be profitable and yet show little improvement on their balance sheets, this is often due to improper structure or poor financial management. Most farmers and lenders would agree that you need to have strong liquidity or working capital. This is measured on the top of the balance sheet by taking current assets less current liabilities, or essentially the current assets that are owned as opposed to a creditor such as a vendor or bank financing them. Having strong liquidity gives the farmer flexibility in how they operate, saves interest, and creates a reserve if they do have a year that is less profitable.
The other important piece of balance sheet structure is that the term of the debt should match and not exceed the useful life of the asset being financed. For example, crop inputs and purchased feeder livestock should be financed with short-term credit such as an operating line as opposed to purchasing breeding livestock that can be financed for three to five years with a term loan. Using the same rationale, farm equipment should be three to five years, buildings and real estate should be seven to twenty years. An important thing to remember when structuring debt is spreading it out over a number of years, which may help the cash flow each year, but creates significantly more interest expense. For example, if a person finances $250,000 to purchase land and terms out the loan for 15 years at 5% interest as opposed to 20 years, they would save $50,000 in interest expense with the shorter term.
At the South Dakota Center for Farm/Ranch Management, we work with producers individually to help them set goals for their operation which will help them succeed financially, improve their balance sheet and grow their operation. To contact one of our instructors, please call us at 1-800-684-1969 or email us at firstname.lastname@example.org. F