Tools of the Trade
As your busy season begins to ramp up and mine winds down a bit, I thought I would take a few moments to share some commonalities that have been flushed out through my discussions and meetings with farm families during the winter. The following are a few of the main questions, areas of concern and things that you can do to address these issues and manage risk.
1. What’s happening with Interest rates?– In short, they are likely going to continue in an upward trend with at least one if not two rate increases of 0.25% percent, with the first increase happening as early as July. Allotting some time to credit portfolio management will likely pay significant dividends over the next 10 years. Ensuring your credit portfolio is structured appropriately, to allow for appropriate timing of cash flow, and aligns with your expected profitability on an average forecast basis, may pay off in reduced interest costs, improved working capital, advantageous marketing strategies and reduced stress load. If you are planning a change in your operation, such as an expansion, large capital purchase, farm transition, etc., taking a pro-active approach to your credit portfolio management now to allow for these changes to occur comfortably will provide you with peace of mind and create a foundation for your farm operation to remain healthy throughout and after that change. You may also be able to re-negotiate existing terms prior to their maturity date and lock in rates now for longer terms before they go up further. Interest rate risk mitigation, by locking in rates and laddering interest terms on long-term debt, is one way you can manage your interest costs now and in future years.
2. How much should I pay for land rent? How much can I afford to pay for land? Should I grow crops or forage?– The unhelpful answer is…I don’t know, but it is critical that you know. The answer lies in your own farm profitability on a per field or soil type basis. Completing a cost of production and profitability calculation is the only way that you can know if your operation is profitable on a per field basis and will provide you with the information you need to make the appropriate business decisions based on your goals and targets. A whole farm enterprise profitability analysis is a good place to start and then drill down into each field or soil type by commodity. There are free apps available, such as FCC Field, to help you collect your crop input data while you are in the field to be used in your analysis later. Both the MB and SK government websites have calculators that can help you with the analysis on a per commodity per field or soil type basis. An advisor that specializes in farm financial management can assist you with your whole farm analysis and provide you with the information you need about your farm financial situation.
3. Working Capital– To be in a financially healthy working capital position you should have at least 50% of the coming year’s operating expenses covered by your own working capital (cash and/or marketable assets that will soon be turned into cash minus debt payable within one year including current portion of long-term debt) at the beginning of the productive season. Have a strong working capital position allows greater flexibility with commodity marketing, ensures adequate timing of cash flow commitments, reduces interest costs, improves your relationship with your primary creditor and significantly reduces stress on management. In addition to your own working capital a detailed analysis of all your sources and uses of cash, including credit, will give you the full picture of your situation and provide you with the information you need to make changes if necessary. Working capital situation should be considered in conjunction with the overall creditor portfolio management and any expansion or transition plans. A farm financial management specialist can assist you with your working capital management and help you create an improvement strategy if required.
4. Cash flow– Knowing your cash flow situation at least 12 to 18 months in advance provides you with the valuable information you need to assess your cash situation and deal with timing issues well in advance of them occurring, align new or existing loan payments, create a marketing plan that aligns with your commitments, plan to strategically deal with surplus cash flow. Analyzing your cash flow situation should be done in conjunction with your working capital situation, your credit portfolio review and prior to any additional cash withdrawals, down payments, new loan payments, etc. Your Financial institution or farm financial specialist may be able to provide you with a cash flow template to use. Start with a whole farm historical and forecast analysis of cash inflows and outflows and then drill down into the month by month analysis. Previous year’s cash flow from your accounting program will be helpful in creating your cash flow projection. A farm financial specialist can help you make sense of it all if you need assistance.
5. I don’t know if I can, or how I will transition from the business? - This is a big problem! Start with figuring out what your cost of living will be and what lump sum cash amounts you need/want in your retirement years and where this money will come from. As Dr. David Kohl stated, when 50% of the transitioning generation’s income comes from off-farm sources the transition will be more successful. So…get a good portion, or all, the money you need to live on throughout your retirement years, out of the farming corporation on an annual basis well in advance of your planned transition period. This will allow you to plan your drawings at a lower personal tax rate while not strangling the farming corporation and the new management’s ability to operate comfortably. There are tax efficient ways to invest your hard-earned dollars personally, or outside of what is needed for operations, depending on your structure. A financially healthy farm operation is critical to the success of a transition plan and it is never too early to start planning your exit strategy. The earlier you start the more options you have, the less tax you will pay and the greater chance that the transition will be successful for the next generation. Your accountant, tax specialist, retirement planner, financial planner, farm management consultant can all assist you through this process.
If you have any questions or concerns about the management of your farm business, please don’t hesitate to contact me.If you have any questions or concerns about the management of your farm business, please don’t hesitate to contact me.