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A clear picture

The mere mention of farm financial analysis can raise more sweaty palms and heart palpitations from farmers than eager enthusiasm. And it’s no surprise. Many farmers would opt to do anything but delve into financial statements, even though they’re key to running the farm business.

“As farmers, you do what you do because you love it,” says Yvonne Thyssen-Post, “and you try to do the best job you can at it as a business.”

Thyssen-Post, a farm business consultant with Thyagrissen Consulting Ltd. in Truro, N.S., sees it as her job to help farmers understand the numbers behind their businesses, and how these numbers can be used to make confident decisions.

Thyssen-Post takes a very straightforward approach to financial analysis — an approach that she suggests farmers can easily take themselves.

It’s a system that Thyssen-Post says will work for most farmers who use accrual-based rather than cash-based accounting methods, since with accrual accounting revenues are matched with expenses as they are incurred. By contrast, cash accounting methods won’t include the things that you haven’t paid for yet, which will skew your numbers.

To start, simply pull together the numbers that show your revenues and expenses for a particular time period, as well as the number of units that you’ve sold in that same time frame. Whether those units are bushels of grain, numbers of bales, head of livestock, hectolitres of milk or tonnes of produce, just use whatever unit you always use to measure the main products that leave your farm.

The best place to find an accurate measure of your revenues and expenses is your farm Income Statement.

Once you have the three parts together for your time period — revenues, expenses, units sold — it’s a matter of one-step math.

Thyssen-Post starts with revenues first. Take each category listed as revenue and divide that revenue number by the number of units sold. The answer will be in dollars per unit sold. Then, do the same for each category listed as expenses, and divide by the number of units sold. When this is completed, you now have a benchmark for you particular farm.

Thyssen-Post says you can use these numbers to compare against calculations from previous or future time periods.

Find the trends

For example, take the income from a sample year and divide it by the number of your units you produced to see how much net income you generated per unit. Then, do the same calculations with last year’s results and compare the numbers from the two years.

Do the numbers show that you’re getting more efficient as a business whose goal is to generate net income?

“When you compare year to year or month to month, for example, you can start to look for trends,” says Thyssen-Post. “Where are you improving efficiencies? Where can you make improvements? What are your decisions actually costing you?”

Once her clients catch on to this approach to financial analysis, they are usually curious to see if and how the numbers will change as their farm grows, such as with land or quota purchases, or with investments in new technologies. Thyssen-Post says these changes are automatically captured.

“As long as you’re always looking at all the revenues and expenses related to a specific amount of units sold, then your analysis will always compute and compare,” she says. “That’s because all the numbers are still broken down by the units that were sold in that particular period.”

For example, if you’re comparing the past year to a current year in which you purchased more acreage, all your expenses for the current year would still be divided by the number of bushels sold — including the additional yield that may have come from that new acreage.

“It really starts to compare apples to apples,” Thyssen-Post says. “Regardless of any changes you make on your farm and whether you’ve made big purchases or not, the numbers you calculate will still show you how efficient you really are with your decisions.”

For farmers who have more frequent income streams such as dairy and poultry farmers, Thyssen-Post suggests doing this analysis monthly or quarterly. For farmers who earn revenues less frequently in the year such as cattle, sheep, crop and produce farmers, an annual analysis will likely work best.

Still, farmers who track more frequently will be able to pick up on changes more quickly.

For an added perspective

Comparing your own farm numbers against those from previous time periods is one great way to see trends. For added perspective, Thyssen-Post recommends finding ways to compare how your farm is doing in the context of others — though it can be challenging to find sound benchmarks.

While there are benchmarks shared through sources such as Statistics Canada, she encourages farmers to check the details about the benchmark information they find. Ask when was it collected, is it up to date, how was it collected, what is included in each category, and what types of farmers contributed the information?

In some parts of the country, farmers are gathering to open their books, share financial numbers and learn from each other. The challenge to building a great benchmarking group is to find ways to ensure all the farmers in the group are categorizing information the same way.

“What’s in vet bills? What’s in supplies? What’s in machinery and repairs?” asks Thyssen-Post. “Make sure all the farmers in the group are recording their expenses the same way so you get a true picture when comparing.”

For farmers who don’t have external benchmarks to compare their farm against, but still want to find efficiencies, Thyssen-Post suggests starting with the high-cost items (per unit sold). For instance, this may mean concentrating on machinery, labour or feed costs. By focusing on these areas first, even the smallest change to find savings on a high-cost item will give you more bang for your buck.

As another check, Thyssen-Post says it can be helpful to look at how the amount of interest paid per unit sold compares with your other high-cost items. For businesses that are just starting out, or that have made significant recent investments in capital, the amount of interest paid on loans is likely to be close to the other high-cost items in your analysis. However, for farms that have been in business more years, having interest paid ranking high among the items in your financial analysis is a red flag and should be thoroughly investigated.

Evaluating future decisions

A structured look at how much you are actually paying for inputs on your farm can also help with decision-making. By using the numbers from this financial analysis, you can evaluate the effects of potential decisions to increase types of revenue streams, decrease particular expenses or spend any money that’s left over.

Thyssen-Post cautions farmers against a common misconception that she encounters with clients. “Remember that net income does not equal the amount of money you have in your pocket to play with,” she says.

For a true picture of the money left over she suggests taking the amount shown as net income from the bottom of the income statement. To this, add back the amount that was subtracted for depreciation. Then, subtract three other expenses that still need to be deducted — the amount paid for that period as principle on loans, the amount paid out for living expenses for your family, and finally the amount to be paid as farm income taxes.

What’s left equals the amount that’s available for spending or reinvesting. If the income left at this stage is negative — the farm has expenses beyond what its revenue stream can support, which means it’s time to dig into the numbers and find areas for improvement.

While you’re evaluating revenues and costs, Thyssen-Posts says, keep your overall goals in mind. In particular, regularly calculating your net worth position helps keep tabs on your farm’s financial health.

The numbers on your balance sheet are valued at cost, not market value, and they are compared against what you have to physically show for your investments. Because of this, a positive net worth is an indication that the business has grown in profitability over time and is worth more than what you invested into it.

However, a negative net worth is an indication that the business has lost money over time.

A negative position can be a real challenge, especially for farms planning to transition. Even so, says Thyssen-Post, effective management always starts with effective analysis, which means a clear picture of where your farm stands financially. CG

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