What a year it has been, with the pandemic altering business strategy and tactics and revamping our personal lives! In the beginning of 2020, many were wondering how the economic and financial events would unfold. However, the rising prices of certain commodities and government stimulus checks resulted in many producers having the most positive bottom line since the great commodity super-cycle one decade ago.
Fast-forward to today and inflating costs in the agricultural arena and other sectors, such as construction, are building a case for possible margin compression. This factor, along with extreme price and cost volatility, requires farms and ranches to keep a foot on the management pedal. The question becomes, is your business truly making money? If not, does your business have the potential to come out on the positive side of the ledger with some proactive shifts in strategy?
Financial monitoring of the cash flow, income statement and balance sheet will be critical in the year ahead. One way to analyze the income statement and cash flow is to divide government payments into net farm income. Since 2016, the U.S. agricultural industry has observed an increasing trend in government support payments. If the summation of these payments as a percent of accrual net income is less than 20%, then your business is in a positive position to be agile and should be able to pivot for life after government support payments. If this number is above 50%, immediate attention is needed to develop strategies and adjustments to prepare for a reduction of government stimulus.
Next, financially shock test your debt service coverage ratio. This ratio is calculated using the cash available to service debt divided by the total debt service payments. How will the reduction of government support payments influence your ability to service debt over the long term? Recently, I was working with a producer whose debt service coverage ratio was stellar at 248%. However, eliminating the government payments reduced the ratio to 114%, which could be considered marginal.
To truly examine profitability, accrual adjusted income statements are highly recommended. This type of income statement requires adjustments in accounts payable, accounts receivable, inventory, prepaid expenses and accrued expenses utilizing beginning and ending balance sheets. This exercise can be an eye-opener to profit performance. Tweaking your Schedule F with these changes can provide the financial transparency needed to make sound short- and long-term decisions.
The period from 2021 to 2023 will be an era of management intensity pertaining to the financials post-government support payments. This emphasis can assist in developing proactive strategies for a business to meet obstacles and adversity, as well as position for future opportunities.
Comments? Please send your remarks to AgGlobeTrotter@accountlist.com. I would like to know what you are thinking.
Ag Economist Dr. Dave Kohl
Dr. Kohl is Professor Emeritus of Agricultural Finance and Small Business Management and Entrepreneurship in the Department of Agricultural and Applied Economics at Virginia Polytechnic Institute and State University. Dr. Kohl has traveled over 8 million miles throughout his professional career and has conducted more than 6,000 workshops and seminars for agricultural groups such as bankers, Farm Credit, FSA, and regulators, as well as producer and agribusiness groups. He has published four books and over 1,300 articles on financial and business-related topics in journals, extension, and other popular publications.