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Dryer conditions could be coming fast: May 28, 2024: Overcoming The Pacific “Warm Blob” | May Svr Storm Stats | Summer Review (’20 v ’24) (youtube.com)
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I made some corrections to the Balance Sheets + Scenarios spreadsheet. Download the updated version. Balance Sheet + Scenarios – Farm640
(PW is ‘farm’)
SW Financial Literacy
How to Get Financed Part 3: Capital
Getting approved for financing isn’t random, the 5 C’s of Credit are fairly well know and used universally:
Character
Capacity
Capital
Collateral
Conditions
Each lending institution looks at these a little different and may prioritize one over another. To get approved for financing, you need to chin the bar on most of the C’s. To get the best terms out of your financing, you want to accel at all 5. The more you know about them, the better you can be prepared.
BIG PRO TIP FOUND AT THE BOTTOM OF THIS ARTICLE
To read previous articles in this series:
Short-Term Capital (Top half of Balance Sheet)
We already built an accurate balance sheet in Part 1 (To build your balance sheet, use this: Balance Sheet + Scenarios – Farm640 Password is ‘farm’), so here we will pull out what you need to be looking at on your statement.
Monitoring and increasing your cash (or liquidity) position gives you the ammo to create growth and financial success while reducing our risk of running out of funds to raise the crop.
Working Capital (Current Assets – Current Liabilities) is how much cash your operation has in reserve or is available to cover expenses. An operation that has no money in a checking account and barely enough old crop grain in storage to pay down the Line of Credit would have a small working capital. Obviously, the more excess cash available, the better.
Current Ratio (Current Assets/Current Liabilities) is the way lenders measure the risk of your cash position. A Current Ratio of 1.50:1 signifies that for every $1.50 of cash (or liquid assets on the top of your balance sheet) you have available, there is $1.00 of debt due to be paid back this year. A current Ratio higher than 1.50:1 is typically considered low risk.
Working Capital and Current Ratios are the most common tools used by lenders but isn’t my preferred way of measuring short term capital. My equation of choice is Working Capital per Acre.
Pro Tip: Working Capital per Acre (Working Capital/Acres farmed) gives liquidity compared to the size of your operation and can better help you understand your short-term capital risk levels as you grow the farm. A farmer having Working Capital of $125,000 while farming 400 acres would have a WC/A of $312.50. If they are planning to add 300 acres the upcoming year, this leaves them with a WC/A of $178.57 which is low. In 2024, aim for a WC/A greater than $300.
Long Term Capital (Full Balance Sheet)
Owner’s Equity (Total Equity/Total Assets) measures the amount of debt compared to your assets and is a pillar for monitoring your financial health. A 55% Owner’s Equity (OE) tells you that 55% of your operation is owned free-and-clear while 45% of your assets have debt against them. Having an OE over 60% is ideal for an established operation.
New or young farmers typically struggle with OE as 60% is an unrealistic goal while you are adding debt. Aim to keep OE above 30% with your first land purchase and try to consistently build your Net Worth.
Net Worth (Total Assets – Total Liabilities) is the wealth you have left over after all debt is paid off. Most finance goals are around Net Worth (I want to be a millionaire!) but there is very little to monitor here. Net Worth takes decades to grow and requires financial discipline to achieve.
Capital Trends (Years of Balance Sheets)
Which direction is your financial momentum heading?
If I showed you a picture of the final score of Super Bowl 51 (Patriots 34-Falcons 28) and told you nothing else, what would you know about the game?
If I let you watch the whole game to see how the Patriots were down 28-3 in the 3rd quarter and came back to win, would you have a better idea of the direction the game took in the second half?
Trending your financials tells the same story. You need to line up at least 3 years of balance sheets (and income statements) to see which direction all ratios went in the past year. It is very possible your Net Worth grew (due to debt paydown) but there were significant decreases in your Working Capital position. Trending financials tells you the story you need to know and should outline what changes the operation should be making for the upcoming year.
Pro Tip: If you are managing your expenses well, producing a good crop, and getting the crop sold in the top 50% of the markets, WC/A should grow most years. A common way to make WC/A shrink is buying a new pick-up, boat, and house right after having what you thought was a highly profitable year!
Pro Tip: If you have two consecutive years of Net Worth losses, this is a big red flag with your finances. TAKE ACTION IMMEDIATELY! Come up with a plan to eliminate expenses, generate additional income, or at least mitigate risks to avoid a third year of losses. Lending options start drying up if this is realized.
Key Takeaways:
Current Ratio -Above 1.50:1
Working Capital/Acre -Above $300/a
Owner’s Equity -Above 60% for established operations and 30% for new farmers making their first land purchase.
Trends -Gives a real update of your farm’s successes and failures from the past year.
Have a great week!
Grant
All views expressed on this site are my own and do not represent the opinions of any entity whatsoever with which I have been, am now, or will be affiliated. Information provided is authentic to the best of my knowledge, and as such, is prone to errors and the absence of key details. The content of this blog is for entertainment and informative purposes and should not be seen as professional advice to finances or any other field.