TEPAP – Day 1

On Sunday, Dick Wittman did a presentation on basic farm financial skills. As a class, he had us take a set of financial numbers and report them on both a cash and accrual basis. I would say less than 10% of the class got the right answer.

Dick emphasized the need to be able to report your numbers on an accrual basis in order to understand if you are really making money or losing money.  Tax basis reports are of little value for managerial accounting.  If you don’t do this, chances are the banker does and can help you generate reports like this.

That was followed up with a discussion on deferred tax liabilities. Dick provided two examples in particular that really hit home on the danger of managing around taxes only. Using section 179 depreciation on machinery while financing that equipment with debt can leave an operation vulnerable to this current economic downturn. Many operations now have loan payments coming due, have to sell grain to pay for that equipment, but have tax due on the income because they have used up the deductions with accelerated depreciation.

The second example focused on how deferring taxes can make you a poor marketer. The example of holding grain when at a high price and waiting until prices are lower costs way more than selling and paying the high price. Marketing should be a separate decision from tax planning. If not, it often drives sales at low price or the wrong time of the year.

Finally, we talked about several key ratios. Debt Repayment Capacity is one of two we discussed that I think is critical to know. Basically when calculated, it simplifies things down to how much cash flow do I have vs. how much debt do I have to service every year. The last ratio that we discussed is the Sustainable Growth Rate Ratio. If your business is growing, this is the maximum rate your business can grow without depleting your assets.

I had a chance to catch up with Dick for a quick interview and you can hear his comments here.

You can find a lot of good free resources here on his website.  I use his workbook with many of my clients and have found it to be very useful.




Accrual Income Statements – Do You Need Them?

Last night I was reviewing a presentation made by Dale Nordquist at the 2013 National Ag Bankers conference entitled “Shortcuts to Accrual“.  The following items are some highlights that stuck out as I read the presentation.

  • 16 of the 21 ratios endorsed by the Farm Financial Standards Council require accrual adjusted income statements.  Balance sheets are not enough.
  • Cash basis income statements average 41% to 67% difference from accrual adjusted statements.
    • For Farms with over 40% debt levels, that average profit difference has been consistently over 60%.
    • Recent history shows cash statements understating income.  That may change in 2014 and 2015.
  • There are two methods mentioned to calculate accrual income: Schedule F and Earned Net Worth Change.
  • The Schedule F method requires fiscal year end balance sheets.
  • If you don’t have fiscal year end balance sheets to match the tax return, then you need to use the earned net worth change method.
  • Handling depreciation and cost vs. market values on fixed assets correctly is important for accuracy.

I would encourage you to download and review the link. It is a good presentation with several key challenges and issues highlighted.



Deferred Grain Sales Lending Index

The Chicago Federal Reserve recently released their 3rd Quarter newsletter on agricultural land values and credit conditions. They included the following graph which shows a huge jump in non-real estate farm loan demands over the past two years going back to the beginning of 2013. I suspect the last two years have included a lot of new paint, buildings and even a few personal expenses in that loan demand.

Deferred Grain Sales Lending Index.

I thought I would have a little fun with the data.    I pulled out the 4th quarter survey results and compared them to the following 1st quarter going back to 1971.   Historically demand for credit goes up in the 1st quarter.  That trend changed dramatically in 2008 as commodity prices took off.  2014 saw a significant reversal of that trend.

As one banker responded when asked who his biggest competitor was, he said “Cash!”

The graph below goes through the Q4’13/Q1’14 and shows how that trend has now moving back to more normal levels.

It will be interesting where we are at after the end of the 1st quarter in 2015.  I’ll update this chart in April when we have the 1st Quarter numbers available.