While on the speaking circuit this year, I overheard a conversation between two producers about their financial statements. One suggested that financials had to be organized and developed to please the banker. The other producer directed a question at him: Do you use the financials to manage your business? The resulting stare said it all.

The perception among some producers is that the financials they prepare are needed only to satisfy bank requirements. Yes, there is some validity to that view. The bank is in the business of assessing and managing risk. However, producers often overlook the benefits of well-organized and accurate financials in managing the business with a modern management mindset. In reality, organized financials create a win-win for all parties involved.

Year-end is a great time to assess the previous year’s performance and map out the financial, business, and operational game plan for the future. This process requires presenting a clear view of your business not only for the banker but also for family members, partners, and other stakeholders directly or indirectly involved in the business.

The Balance Sheet

A foundation of the financial planning process is the balance sheet, as it provides a snapshot of your business assets, liabilities, and equity at a given point in time. It is important to maintain an inventory and corresponding schedules of depreciation and liabilities to support the balance sheet. An inventory of livestock, machinery, and equipment with serial numbers and livestock identification numbers can be valuable not only for the banker who may hold them as security, but also for insurance companies or internal business arrangements. The number of bushels in the grain bin or tons in silos, along with reasonable market values, can provide a roadmap for future operations.

The trends in accounts receivable and accounts payable, along with any accrued expenses such as payroll, interest, wages, inventory values, and prepaids, provide a glimpse of performance. Regarding bottom-line equity, did it increase, remain the same, or decrease? Was the change the result of earned equity or shifts in asset values, such as inflated land prices?

More producers are developing separate business and personal balance sheets as business complexity grows. The home, personal assets and liabilities, vehicles, retirement program values, and personal credit cards are listed separately. This distinction allows for a more refined analysis of business performance, avoids commingling of funds, and presents greater transparency in both business and personal financial information.

The Projected Cash Flow Statement

A projected cash flow statement, combined with an operational plan for production, marketing, revenue, expenses, and timing, represents roughly 80 percent of a business plan. It provides guidance on your ability to meet expenses and service debt, as well as family living withdrawals and potential capital expenditures. A monthly or quarterly cash flow, regardless of revenue and expense streams, is critical for determining the need for operating lines of credit and scheduling term debt payments. This assists both the owner or manager and the bank in assessing repayment ability by illustrating repayment capacity, debt-service requirements, and peak operating credit needs.

Surpluses or financial cushions offer valuable insight into the business’ ability to absorb financial shocks. Generally, your banker will want to see a minimum coverage ratio (repayment capacity relative to debt-service payments) of 125 percent to provide this cushion.

Financial Sensitivity Analysis

In every plan, wild cards can be expected. Prime examples include weather, tariffs, disease, inflation, and sometimes simply the execution of the plan itself. Paramount in any planning process is testing assumptions in spreadsheets, such as production, price, interest rates, and costs, to determine their impact on the bottom line. This establishes guardrails so that decisions can be made more objectively rather than emotionally or subjectively for both short-term and long-term goals. It also provides another tool for assessing opportunities and monitoring performance throughout the year.

Family Living Budget

Often overlooked in the financial business planning process, particularly as it relates to cash flow, is the family living budget. With more generations taking withdrawals from the business, and with inflation affecting insurance, real estate taxes, child and adult care, and educational needs, a family living budget becomes a priority. More farmers and ranchers are also investing outside the business. Contributions to retirement plans need to be identified in both number and amount. Debt service on vehicles, home mortgages, education, and credit cards also needs to be clearly outlined.

Income Statement

A Schedule F tax record is often not an accurate depiction of profits. Revenue, expense, and depreciation rules can distort net income, frequently showing losses in order to minimize income taxes.

More high-performing businesses are developing accrual-adjusted income statements based on their tax records. This process requires adjusting beginning and end-of-year inventories, receivables, prepaid expenses, accounts payable, and accrued expenses for both increases and decreases. Accrual-adjusted income is regarded as the true measure of business profitability, and bankers view these statements favorably when evaluating repayment ability, profit generation, and growth potential, as they provide a more accurate picture of overall business performance.

Goals

Intertwined with year-end planning is the development of goals and aspirations that support the financial documents. Mapping out and writing these business, family, and personal goals can be valuable in maintaining focus on the controllables, managing around the uncontrollables, and assessing trends and performance.

Year-end planning can be one of the most valuable steps in positioning both you and your business for success and improving the bank’s odds for repayment. Most importantly, it can serve as a tremendous communication tool for all parties involved in the business.