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Finance has its own language that may be confusing
Associate Editor

COLUMBUS, Ind. — One shouldn’t have to be Agatha Christie to deduce how best to appeal to loan officers for a farm loan, but finance has its own language that sometimes confuses or intimidates applicants.

“This is not rocket science,” said Summer Goldman, regional vice president of Farm Credit Mid-America. “If you can add 1 and 2 together, you can (keep track of your farm’s worth). What the hard part is, is the vocabulary.”

Goldman led off her presentation on Understanding the Financial Performance of Your Farm at last week’s annual Purdue University Women in Agriculture Conference by asking people to voice their concerns. One farm wife explained her father-in-law left the farm to her husband and another relative who isn’t farming, but wants to get into it.

Another wanted to know if her farm’s income and expenses are in a “reasonable” range. Yet a third wants to add livestock to an organic produce farm, but doesn’t know if it’s worth the trouble financially.
Updating a balance sheet for the farm at least once a year has the benefit of giving the owners a ready snapshot of their assets and liabilities and being a document that will better help a loan officer decide how to proceed when it’s time to visit them, Goldman explained. She told attendees what she looks for in reviewing applications.

First, she recommended doing the balance sheet on the same day each year – her personal preference as her own farm’s record-keeper is Dec. 31, because it’s an easy date to remember and goes along with the calendar and many operations’ fiscal years, too.

Doing it the same day allows one to look back at past years’ balance sheets and see the growth (or decline) of the farm at a glance. This is called “trending your operation,” and another good source of trend information is in your farm’s crop insurance records from past years. The point of trending is to look for “significant changes” from year to year and over a period of years.

Multiple years’ balance sheets (at least three) is also something Goldman said she reviews for applications at Farm Credit – along with tax returns – to help figure out if the applicant is a good loan risk. If the farm is improving, even a little, each year, it reflects well on the applicant.

(Though it is the end of February, Goldman suggested if any farmers wish to start keeping a balance sheet now, they can probably still easily go back just the two months and date this first one as Dec. 31, 2012, and make their list according to what they had and what they owed on that date.)

A resource she said might help is the Purdue University publication Measuring and Analyzing Farm Financial Performance, which can be found online at media/EC/EC-712-W.pdf

She also recommended looking into FAST Tools software – this is a program many farm women know from having taken “Annie’s Project” classes in various states.

Second, when compiling the balance sheet, Goldman advised using fair market value for listing the worth of land and equipment. For example, she pointed out if a farmer lists his land is worth $15,000 an acre and applies for a loan, and the nearest real sale value she can find in proximity of his farm is $10,000 an acre, that’s likely the ceiling she’ll allow him, too.

“If they fluff things a little bit, it’s only going to hurt them later,” she said, pointing out if a farmer does manage to get a loan in excess of his actual resources, based on inflated information, he may not pay it back in time to keep in good standing for future loans.

Common terms to know

A balance sheet is assets and liabilities – what you have, and what you owe. Current assets are cash and what can be immediately liquidated, or sold, for ready money; non-current assets are not easily disposed of, such as land or crops in the ground. Similarly, current liabilities are those which need to be paid back in the short term, perhaps the next year – like rent, seed costs, loan principal – while non-current liabilities are longer-term, such as mortgages.
Current ratio is total current assets divided by current liabilities. This should be at least 1:1, Goldman said, but 2:1 is better for farm financial health since it shows more owned (or at least coming in) than owed. “You can pay your bills,” she pointed out of a 1:1 ratio, “but I’m not sure you can eat.”

Working capital is current assets minus current liabilities. Goldman said normally for this, Farm Credit gives a little more leeway to crop operations than livestock, only because an animal can be sold more or less immediately (even if not at the ideal price) if necessary.

A crop, however, has to finish growing before it can be transported.
Solvency is total assets minus total liability, divided by assets. She said 50 percent or higher is good. “This is a hard number for young farmers” to attain, she pointed out.

Capacity, or profitability, is the core ratio of importance, Goldman said. It’s a complex formula, of net income divided by the total of: net income + depreciation – income taxes – family living – debt service repayment – working capital deficiency. Ideally, this number should be 115 percent or higher.

The “family living” shown in there is nebulous area, since each family’s needs for daily life differ. Most wage-earners, Goldman pointed out, live on what is left over of their salary after payroll deductions and personal savings. Farmers are different.

She said generally, $20,000 is figured for a couple or $40,000 for a family of four on a farm, for purposes of the balance sheet.
But, “I would like to know what family of four can live on $40,000 a year,” she remarked with some humor.

The downside of trending, she said, is there are always exceptions to a rule. Just looking at raw numbers doesn’t tell her as a loan officer, for example, what factors might be influencing them. Was there a management change? How have recent higher crop prices skewed a farm’s trending over a period of the last 10 years, for example?

Ending on a personal note, Goldman believes it’s vital for farm parents to expose their children to discussions about their finances from an early age, so when they’re teenagers and deciding on a career path, they know what farming entails.

She said her six-year-old will sometimes be doing homework at the table when she and her husband are discussing financials – and while obviously too young to participate in the discussion, is beginning to pick up on the importance of accounting and planning.