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.