September 6, 2018

Northwest FCS News

The economic times facing the agriculture industry are fluid with significant changes occurring at the macro level in trade, markets and weather that can quickly change the bottom line. One of the concepts that your lender is going to employ is accrual analysis of your business financial performance. They will request a balance sheet and three years of tax records as a standard procedure. However, many lenders are going to go to the next step and closely examine what is occurring in key areas of their borrowers’ finances.

The key areas being analyzed by lenders are changes in current assets and current liabilities such as accounts payable, crop and livestock inventory, crops growing in the field, prepaid expenses and accounts receivable. Expenses may be accruing and not being paid due to cash flow shortages. In addition, some producers may be having issues collecting their accounts receivable or may be selling inventory in advance to meet cash flow shortages.

I recently facilitated a financial literacy class for a pilot group of producers. This group conducted accrual analysis on their businesses. The following are some of the interesting comments from the class:

  • “I lost over $100,000 according to my tax returns. However, when crop and livestock inventory changes were calculated at the end of the year, the business made $150,000 in accrual profit. Wow! I did better than I expected.”
  • It simply says a lot about those pesky accounts payable. When profit was adjusted to an accrual basis, the result was a $300,000 loss due to the change in accounts payable from beginning to ending balance sheets. Ouch!”

The latter realization was a slap in the face to the producer. This producer also said that they hoped their lender would refinance their payables for three to five years to stop the bleeding. In this situation, if corrective action is not taken, the business Band-Aid could give way to hemorrhage again in three to five years.

Other producers indicated that they were surprised at how large the differences were between cash and accrual profit. Many producers reported $250,000 to $600,000 differences, both positive and negative.

The point of this article is not to make you into an accountant. It is to alert you to how cash to accrual changes in the accounts previously discussed can provide a truer depiction of your financial performance and financial situation. I recommend that you schedule a meeting this fall with your agricultural lender and dig deeper into your business’ financials.