3 steps to pump up your financial fitness

Whether in pursuit of better profitability or lifestyle changes, avoiding inaction is imperative.

Applying the same principles to farm business fitness as our fitness can result in many parallel benefits, such as improved flexibility and increased strength. Both, however, take work, points out Mark Verwey, partner and national agriculture leader for BDO.  

For our farm businesses, evaluating and working on financial fitness means analyzing and understanding working capital, debt service ratio and debt to equity ratio while being willing to act on business priorities rather than assuming the status quo is OK.  

Here are Verwey’s three steps towards financial fitness: 

1. Don’t assume stability 

Just like the body, a business can be in a state of growth or decay. Assuming everything is stable, says Verwey, is a common mistake and can make it difficult to highlight where decay is occurring.  

“Never assume stability. Always assume decay or growth and ensure you’re on the side of growth,” says Verwey. 

On the farm, looking at the bottom line is the best way to assess whether you’re in growth or decay. Examine updated balance sheets and statements of operation on an accrual basis. 

“Numbers don’t lie. There’s always a correlation between the numbers and the reality of that farming operation,” says Verwey. “Do not rely solely on cash to determine whether you are successful or not.” 

2. Know your ratios  

Flexibility comes from a healthy working capital (or current ratio) calculated by dividing current assets by current liabilities. Highlighting your liquid capital and whether there’s enough available to finance the next year’s production is critical. The higher the ratio, the more control you have, and the need to sell assets to pay for the following year’s production is less likely.  

A debt service ratio is at the heart of every farm business — what Verwey says is the most important ratio to understand — as it establishes whether you can service existing debt. This capacity is determined by dividing net operating income by debt to service (principal and interest). Being above the minimum debt service requirement means farm operators could take on more debt should they see growth opportunities. Being below, conversely, makes it hard to grow.  

A business’ strength is its debt-to-equity ratio, or the total amount of external debt compared to your equity in the farm operation. This can be a straightforward comparison, but when it comes to assets that might have risen in value (such as farmland or real estate), Verwey cautions against using current market values. By keeping the asset's value at what it was originally purchased for, business operators recognize such assets are fixed rather than liquid and avoid masking problems with inflated values. In situations where operators struggle to match assets with debt, however, accounting for current market prices can play a role.  

3. Set priorities to move ahead 

With an accurate financial picture, the next step is identifying what actions will achieve your operational goals. Identifying changes can be made easier by ranking the impact of various decisions – Verwey employs a 1 to 10 rating scale – and how easy each will be to implement - a 1 to 5 rating scale is recommended. Add the two ranking numbers for each option and prioritize the one with the greatest value.  

Whether in pursuit of improved flexibility or increased strength, Verwey says avoiding inaction—that all-too-comfortable feeling that everything is stable—is imperative, whether on the farm or in our personal lives.  

“Many small changes lead to big results,” says Verwey. “If you don’t plan, you plan to fail. Make sure you have a plan going forward.” 

Article by: Matt McIntosh