An annual financial review is part of your risk management strategy; it’s is an integral part of business activities. Just like good personal and production health starts with the basics, so does the financial health of your farm. We recognize the importance of regular medical and dental checkups for ourselves, we have regular maintenance schedules for our equipment, but we often ignore the heart of our business, the motor that keeps everything running — our finances.
There are three key elements to the financial review: financial accuracy, timeliness and perspective.
Financial accuracy is essential; your assessment is only as good as the data you are using. Make sure that your bookkeeper (whether you, your partner or an employee) has some training. Basic financial analysis (the kind done on a monthly basis) is not rocket science. A good bookkeeper understands the basics of financial reporting and analysis. (An accurate set of books provides the added advantage of allowing you to estimate your personal spending — an area much ignored or under-estimated by farmers).
A second key element is timeliness. The bookkeeper (including you) should give regular feedback, and prepare information in a form that is useful to whoever is doing the analysis (including you!). Bookkeeping is much more than plugging numbers into a journal, a spreadsheet or a computer program. If you are doing your own books, take time every month (yes, really) to review the month’s financial activities — not just if there is money in the bank, but what else happened (financially) during the month. What is your budget to actual comparison? If you do not have the time, the skills or the desire to do this, then paying a well-trained bookkeeper is a wise investment.
Finally, get outside assistance. No matter how skilled we are, at times we need unbiased third-party assessments of our operation. Why? Because we are not experts in all aspects of farming nor can we be totally objective about our own situation. We do not hesitate to contact production specialists with questions about fertilizer, new crops or weed problems. This outside perspective is especially important when doing the annual review — when the tax returns are completed, the financial statements have been prepared and you are planning next year’s activities. A neutral outsider can assess the situation, ask questions and provide insights about your operation that we either don’t recognize or won’t acknowledge.
Who do we get to give us this second opinion? The accountant or banker can provide insight, but often their input is limited by time, and the questions you ask. Consider contracting an independent consultant, such as a member of CAFA (Canadian Association of Farm Advisors, www.cafanet.com), who work one-on-one with all types and sizes of farms.
WHAT’S IN AN ANNUAL REVIEW?
What is involved in doing an annual review or assessment? Whether done by you, or with the assistance of a consultant, it need not be an onerous task; a few simple steps will suffice. All you need are the year-end financial records (actual and budget amounts), inventory figures, your income statement and your balance sheet. Your budget represents many of your financial goals, including savings for capital replacement and growth in owner equity. Compare the year-end actual to the budget. Where did you overspend? Under spend? Why? Is your income what you expected? Why or why not? Has your debt load increased or decreased? Are your capital replacement goals on track? For example, if you are saving to build a new house, how is that going? Reality check: Are your efforts taking you where you want to go?
It is very important when doing a review to use accrued information. The Canada Revenue Agency allows farmers to file their taxes based on cash accounting, but to be meaningful, analysis and management decisions must be made using accrued data. This is a relatively easy process PROVIDED accurate financial and production information is available. A small fee for good bookkeeping or consulting services pays dividends here.
Consider this very simple example (Table 1):
Farmer Jones and Farmer Smith farm in your community. The tax return for each farmer shows Farm Revenue of $500,000; Farm Expenses of $375,000 and Farm Net Income of $125,000.
However, Farmer Jones sold all of his grain crop and his calves in 2010, while Farmer Smith still has half of his fall grain crop in the bins, and his heifer calves are in the feedlot. Farmer Jones also has an unpaid fuel bill of $5,000 at the end of the year, while Farmer Smith’s bills are all paid and he has pre-purchased $10,000 of fertilizer to use next year.
Looking at this very simple example, and assuming that all other factors are equal, you can see that Farmer Smith is in a much better financial position, even though both had to pay tax on the same amount of income. If Farmer Jones did not review his financial situation at the end of the year, he might assume that he was much better off than he really is. This assumption could cause Farmer Jones to make poor financial decisions — decisions which could negatively impact his business in the future.
“But I can’t afford a bookkeeper or a consultant!” is a common refrain. You likely spend significant dollars every year on preventative maintenance for your equipment; you spend thousands on chemicals and fertilizers to grow better crops; you buy crop insurance in case of drought or hail — all to earn more income. But where is the financial maintenance? Your finances are the motor that keeps all of the other parts running — if that financial motor breaks down, the whole operation is thrown into disarray. The cost of a consultant to assist with the annual financial review is a small price to pay for the financial health of your farm.
KathyStables(CAFA),aformerfarmer,isa businessmanagementconsultantspecializing inprimaryagriculture.Contactherat [email protected] formoreinformation
$500,000 $0.00 $0.00 $500,000 $375,000 $0.00 $0.00 $5,000 $380,000
TABLE 1: A SIMPLE ACCRUAL ADJUSTMENT FOR TWO FARMERS (ASSUME ALL OTHER FACTORS ARE EQUAL).
Farm Cash Revenue from 2010 Tax Return
Less 2009 production sold in 2010
Plus 2010 production on hand at year end
= Accrued farm revenue 2010
Farm Cash Expenses from 2010 Tax Return
Less 2009 expenses paid in 2010
Less 2011 expenses prepaid in 2010
Plus 2010 expenses unpaid at year end
= Accrued farm expenses 2010
Accrued Net Farm Income 2010 Farmer Jones
$500,000 $0.00 $250,000 $750,000
$375,000 $0.00 $10,000 $0.00 $365,000