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How Do Farm Financial Decisions Impact Your Financial Strength?

By Don Nitchie, Extension Educator

It is a good time to evaluate your financial and profitability goals for 2016 and beyond.  Your balance sheet for your operation measures your financial strength, ability to bear business risks when opportunity knocks and your financial progress over time. Changes in your balance sheet directly occur as a result of your overall profitability and where you choose to invest or spend those profits. Profitability and the choices you make are the major drivers of these financial measures. While the financial measures discussed here for many Minnesota farms remain strong, they have also been declining since 2012 for most farms.

Goal--Improve your Liquidity.  Liquidity is the ability of your business to pay all current liabilities/obligations with only the current assets, (grain & market livestock), that are on the books at a point in time.  It is commonly measured by the current ratio = current assets/current liabilities with a ratio of 1.7 or 2.0 or above as strong and 1.3 or below as weak. Much concern has been expressed about the decrease in liquidity for some producers over the last few years with lower crop prices. So, if your liquidity has declined to a level that  is less than you feel is desirable -- what actions will work to improve this ratio and therefore your comfort margin in your ability to pay your operating loan and other annual loan payments?  Increasing this ratio is desirable and decreasing it usually is not.  See the table below.

Goal--Improve Your Solvency.  Solvency is a measure that states the health of your total balance sheet of your business, beyond just the short-term or current condition for the next year. As a percentage it states the relationship of your total debt to total assets. It is the ability of your business to pay all of its debts/obligations if it were sold today.  It also is a measure of your ability to bear risk and capitalize on opportunities.  If your total farm debt/total farm assets is 30% or lower your condition is very strong. If you’re total farm debt is 60% or more of your total assets—this is a concern and your business is vulnerable. Increasing this percentage is not desirable, decreasing it usually is desirable.  See the table below.

As you can see, your financial condition or strength as measured by your balance sheet has several moving parts to it.  Although we did not show it, none of the actions in the table above changed Net Worth. It is good to understand and clarify the impact a decision and the resulting action will have on your total balance sheet.  Also remember that your marketing of not only current production but, also past production in inventory can change the impacts above significantly. Selling your grain, market livestock or milk for 5% better prices on average, will increase your liquidity better than just average selling prices.

Source: Jim Kurtz, SWMFBMA April 2015 Newsletter

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