Find Your Silver Linings
October 15, 2018
Featured Guest Writer: Lacey Coleman, AgChoice senior accounting officer
No one who relies on the dairy industry for a living needs to be told that the industry is facing challenging times right now. Every dairy farmer knows the challenges first hand. Dairy industry professionals can only hope to have the right words when dairy farmers share their concerns with them.
Abraham Lincoln once said, “We can complain because rose bushes have thorns, or rejoice because thorn bushes have roses.” I’m not trying to paint a rosy picture, but I do strongly believe in the power of positive thinking and find it important to look at some of the silver linings I’ve seen in farm financials over the past year.
Cash flow is tight. While that is an absolute true statement, it is important to remember that the checkbook is not the only gauge of one’s financial picture. Many of the silver linings I’ve seen on farms actually come from the balance sheet.
To analyze the financial health of an operation and gain an accurate measure of profitability, farms need to look at both cash flow and the balance sheet. This is accomplished by doing an accrual analysis of the operation’s financials. An accrual analysis takes into account changes in inventories, accounts receivable, accounts payable and prepaid expenses.
While cash flows are struggling, farms can still have positive accrual earnings. This could be the result of improved inventory values on the asset side of the balance sheet.
For most farmers, the 2017 crop year yielded better results than the prior year, when a large portion of Pennsylvania had poor growing conditions. Crop inventories recorded at year end 2017 were much stronger going into 2018 and helped bolster balance sheets. This may mean less purchased feed cost or an additional revenue source for farms.
In addition, livestock inventories have increased on many farms. You could look at this point in many different ways, just like the increased production and efficiency factors seen on farms. Some may say that increased herd size only adds to the supply issue. Some may say that a high replacement rate of heifers is a drain on cash flow. This may just be a result of timing, hoping for improved market prices. Regardless, an increased livestock value on the balance sheet can help create positive accrual earnings.
Prepaid expenses were not as prevalent at year end 2017, therefore not having as much impact on accrual earnings. However, prepays continue to be a management tool on many farms. If used effectively, prepaying is an excellent tax management tool and enables farms to take advantage of vendor discounts.
From a liability standpoint, most producers have seen higher accounts payable as they try to manage cash flow with vendor credit. While this negatively impacts accrual earnings, as long as principal pay down outpaced payables and operating debt accumulation, then that is a positive for the year and something to feel good about in these challenging times.
While every farm has a unique income tax picture, the constant is the deferred tax liability that capital assets depreciation creates. While many don’t even realize this, some farms were able to better maintain their deferred tax liability in 2017 by slowing depreciation methods and forgoing accelerated depreciation (section 179 and bonus depreciation) when lower income was recognized on the tax return.
The most important step in an accrual analysis is completing a balance sheet at the end of each year. With a beginning year and ending year balance sheet, you can easily make the accrual adjustments, keeping any market revaluation in mind. If you need help, reach out to your accounting professional. Accrual earnings are most often used by lenders and in industry benchmarking, so having an understanding of cash flow and balance sheet changes is more important than ever.
Try to find the silver linings in your operation to help ease the pain those thorns are creating right now. “Positive anything is better than negative nothing” (Elbert Hubbard)