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Tips for Managing Your Farm Finances
It takes more than a love of the land and good weather to farm. It takes a sound business head. Managing farm finances may be the most difficult part of making a living in agriculture.
Taxes, operating loans, major capital purchases, labor costs – all require knowledge of financial rules and products, not to mention a good relationship with your banker and accountant.
Here are some of the things you will need to know to effectively manage farm finances to ensure profitability.
The ever-present taxes
The 2017 Tax Cut and Jobs Act brought several changes to the farm tax picture. Aside from the personal income tax changes, depreciation rules improved for farmers, 1031 exchanges of farmland can still be tax-deferred, and a 21% flat corporate tax rate will help C-corporation operators, as will a new pass-through deduction taken at the shareholder/partner level.
An often-overlooked tax measure can help the innovative farmer. The Research & Development (R&D) tax credit can be applied to experimentation with new products and practices such as livestock feeding and cover crops.
There are mistakes to avoid. Experts caution against creating an entity structure that is either too simple or too complicated. The right one will ensure you get the most from existing tax code. The same goes for contributing too much or too little to your retirement plan. Mostly, it is important to know where you are with current and projected income and understand the relationship between debt and taxes.
The agri-finance picture
From banks that specialize in ag loans to private equity firms that invest in farmland, there are big players in ag financial circles affecting the picture on the ground. Farm Credit Services of American and Farm Credit Mid America account for around one-half of the ag loan business, funding 50 ag credit associations.
Not all investors are banks. MetLife holds an ag portfolio of more than $16 billion, many pension funds include ag investments, and foreign sovereign wealth funds own land and ag assets worldwide. Of course, there are individual investors as well from the U.S. and across the world.
Ag loan holders like Rabobank remain optimistic as long as land values hold and farm debt levels remain reasonable. The prospect of rising interest rates will increase operation capital needs, particularly operating loans. Operating loans account for around 60% of non-real estate loans through commercial banks.
Recent years bring a drop in farm income
Interest rates these days are relatively low compared to historical highs. Unfortunately, so is farm income. Commodity prices and resulting net farm income have been in a downward trend since 2013.
Across the farm belt, banks are reporting loan “watch lists” of 15-20%, reflecting their caution as to farm lending and repayment. In an era of razor-thin margins, those who control direct costs, know their financial position, and have a plan for profitability are pegged with the best prospects for survival.
The amount of working capital continues to decline across the ag sector, signaling a decrease in liquidity. From 2009 to 2012, working capital in the U.S. farm sector dropped by 64%. For the farmer, that means more borrowed money to invest in assets and replace worn out machinery. Working capital now stands at just 13% of gross revenues, compared to 45% at the peak.
Ways to reduce costs and increase revenue
Salvaging your farm’s financial prospects depends on the age-old advice of increasing revenues and minding expenses. But neither is simple on the farm. Identifying the greatest cost drains is key.
The percentage of gross revenues that convert to profit (not including interest or depreciation) should be at least 25-35%.
Re-assessing land use for the most profitable crops, looking at net profits field by field, and reevaluating family living expenses can help, as can taking a scrutinizing look at your machinery inventory. Changing farming practices to include no-till or contracting with custom operators can reduce machinery needs.
Some farmers are opting to tap into the sharing economy, partnering with neighbors on equipment and labor. In some cases, purchasing can be streamlined through buying direct from the manufacturer or through a buying co-op.
The good news about an economic downturn is those who survive will be better than ever. That’s not much comfort when you are on the edge of survival. But farming is a cyclical business.
Surviving the 0% profit times takes close scrutiny of both business and personal balance sheets. Everything from utilities, to insurance and rents are on the table. Restructuring debt can help reduce debt service payments, freeing up cash and buying some time. Look especially for unnecessary debt on items like personal vehicles and excess machinery. There is also no need to stockpile supplies if cash is tight.
Additional revenue can be found by using trucks for local hauling jobs, or taking repair work into your shop. It’s all about frugality and creative problem solving.
Refinancing and bankruptcy
If you need to refinance, there are rules to follow, and it’s likely your lending institution does. The first is the Rule of 90. This states the sum of the loan term plus the loan-to-value ration may not exceed 90. The second is a debt service limit (the percent of net income that goes toward annual loan payments) of 85%.
In addition, lenders consider it prudent for you to fund at least 25% of operating costs with your own cash, and to finance no more than 75% of the value of equipment.
Should your worst nightmares develop, and you are forced to file for bankruptcy, it is important to know how it will affect your leases. Both state and federal laws apply. There are issues for both landlord and tenant, including the stage of the crop cycle.
It’s important to seek professional advice on matters of bankruptcy as well as ongoing financial management. With good advice and common sense, you will remain productive on the farm for years to come.