Year-End Financial Check-Up
We recently interviewed Larry Labowski, a Farm Credit loan officer. A year-end financial check-up has many benefits for farm businesses.
Larry discussed what should be included in a year-end check-up and resources available to help.
Could you share the couple of key items that you feel are important for farm businesses to update during this time and why they are important?
Understanding the current state of your business helps you understand your performance and make a plan for the next year. I’ve found that farms and businesses that take the time for a financial review are better prepared for what may impact their operation in the future.
The first step of a year-end financial checkup is to update your balance sheet, both a personal balance sheet and business balance sheet. A balance sheet is a snapshot of your business at a point in time. Creating a balance sheet on Dec. 31 each year enables you to see how your farm operation has changed. Did your net worth grow or did it regress? If it grew, was it from earnings or asset valuations? If equity is trending downward, how much is the business and/or family willing to lose? Keep in mind that a balance sheet to monitor your operation’s performance may be different than your balance sheet to secure a loan, which often includes your personal assets and liabilities. To measure a business’s performance, the balance sheet should include assets and liabilities only for the business. This requires you to consider who owns each piece of equipment and parcel of land and then determine if it goes on a business or personal balance sheet. These values impact many indicators that are important to evaluating financial performance.
Profitability is critical to the success of any business. To best assess your profit from the previous year, create an accrual-adjusted income statement, which adjusts for items including inventory and prepaid expenses. An accrual-adjusted income statement allows you to generate a cost of production on a per unit basis to use in other areas of decision-making, including the use of risk management tools such as crop insurance. Understanding your income and expenses is important for tax planning purposes, and especially in a year like 2020 where we’ve had many unexpected factors impacting both. Many times, farmers avoid paying taxes at all costs, but don’t make a tax decision that puts your business in a worse position down the road.
Lastly, take time to complete an operating and capital expenditure (CAPEX) budget for the coming year. Remember that failing to plan is planning to fail. Review your income and expenditures from the past year and put together a monthly budget for your business. For your CAPEX budget, consider the capital investments you will make in the next year and how you will pay for those investments. Budgets are never 100% accurate, but they provide a starting point for planning for the upcoming year. As the year progresses, review and adjust your budget often to reflect what is happening in your business.
Those are some important aspects that farm businesses should consider this time of year, but many operations might be concerned about how to accomplish all of these items. What resources are available to help?
Yes, tackling all of these items with a year-end financial check-up might be intimidating, especially if you haven’t done them in the past. I encourage you to involve your operation’s key advisors in helping with you.
Lenders like Horizon are particularly interested in your balance sheet to see how your business fared in the prior year and your budgets for the upcoming year. We have a number of resources including forms and instructional guides to give you background on what to include in these areas. In good and bad economic times, it is always a good practice to maintain open lines of communication with your lender about anticipated capital needs.
I also encourage farms to engage additional advisors, such as the accountant, feed consultant, crop insurance agent and others who are willing to help. All have a vested interest in the success of your operation and can best advise your business with accurate and up-to-date information.
Is there anything else you’d like to share with our listeners today?
I would like to add about the importance of knowing your own records. At year-end, when you are calculating your accounts payable and accounts receivable, be sure to be as accurate as possible. The most common error that I see is reporting an accounts payable when in fact the expense was deducted in the prior year because they signed a promissory note. In this case, you would be overstating your accounts payable and increasing your accrual adjustment to your expenses and then understating your accrual-adjusted net income.
But that’s getting pretty deep into the weeds, and it is a great discussion after you start your annual financial check-up.