New farm financials? Check operating income first
What kind of year, financially speaking, did your farm have? You’ll have a partial answer already, based on what you know about production, prices and expenses for that 12-month period.
Still, it’s only when you receive your financial statements from your accountant that you’ll know for sure. Once you have these statements in hand, where do you start? What should you look at first?
Operating income is the ability of an operation to generate cash that’s greater than its expenses.
According to Lisa Kemp, partner with BDO Canada in Lindsay, Ont., the place to start is the figure for operating income in your income statement. Operating income is the ability of an operation to generate cash that’s greater than its expenses. Commonly referred to as EBITDA (earnings before interest, taxes, depreciation and amortization), this is the income available to fund capital obligations and new investment.
“People often think the bottom line is what matters most, and they go there first,” Kemp says. “The bottom line, however, often reflects certain adjustments for that particular year, whereas operating income is more normalized.”
Looking at your operating income will reveal a lot. Even more insight comes from understanding how that figure has varied over the past five years. This is something Kemp likes to emphasize in her discussions with clients.
“In this area over the past five years, for example, farmers have seen some highs that were very high and some lows that were quite low,” she says. “It’s important to look at how operating income is changing over that period, and not focus on just the past year.”
Next, compare income to debt by calculating the farm business’s debt service ratio. Even if the dollar amount of debt looks high, it must be viewed considering the operation’s ability to pay.
“The level of debt only becomes an issue if there isn’t enough cash to service it,” Kemp says.
With her firm serving clients in all farm sectors across Canada, Kemp urges clients to go a step further. Compare your 2020 results to similar operations in your sector and in your region. This is something to ask your accountant or FCC relationship manager about. The results might surprise you.
Says Kemp: “People often feel that they’re not doing well enough with their finances. This kind of benchmarking can help you see, yes, I am a strong manager. And that’s something to celebrate.”
Planning to take on more debt? If you have a debt service ratio of 1.25:1 or higher, you should feel confident. Search “ratios” to read more on what this means at fcc.ca/Knowledge.
If you feel you are doing less than ideal with your finances, FCC’s online cash flow planning guide can help you learn and grow in this area.
From an AgriSuccess article by Kieran Brett.
Learn about the 3 financial statements and 5 ratios every farmer needs to assess the health of their operation’s bottom line.
Taking on debt, when understood and used properly, can be an effective way to help you reach your business goals.