Financial modelling: A crystal ball for smarter risk decisions

Farmers face a multitude of decisions throughout a growing season, and with the proper business tools, you can be well-prepared to roll through the production year. A robust business includes planning to identify the essential tools and tactics needed to be prepared for the years ahead.

J.P. Barnabé, a partner at BDO Canada in its financial advisory services group, says two of those tactics are careful and regular financial modelling, coupled with regular reviews and mid-season budget adjustments. Both are designed to reduce worry and costly missteps.

The importance of financial modelling

Financial modelling uses historical data and assumptions to forecast a company’s future performance.

In any industry, including agriculture, a proper financial modelling system allows owners to take a high-level look at a situation and truly understand the overall picture of their business. Simply put, financial modelling uses historical data and assumptions to forecast a company’s future performance. It covers revenues, expenses, cash flow, debt servicing and capital expenditures. Models are usually built in spreadsheets or software, like FCC AgExpert, to organize data and guide strategic decisions. Without this, it can be difficult to grasp a farm’s financial health.

“It’s important to understand that from a debt and cash flow perspective, but also to plan what that might look like going forward,” Barnabé says. “If you’re looking to expand or if there’s some significant cash outlays that are occurring, what does that look like? How are you going to be able to make those payments?”

Many factors impact a farm’s finances, so knowing cash flow and financial modelling is imperative. For example, in seasonal or production cash flow cycles, agriculture tends to have high costs and little income in the spring, with lower costs and more income in the autumn.

Poor financial planning results in anxiety, potentially costly missteps

Barnabé encourages farmers to break the norm and first look at their financials before the end of the growing season.

“There are too many farmers out there that are still doing their books on a paper ledger,” he says. “Depending on how often they’re updating that, they might not have any idea what position they’re in at the end of the day.”

A feeling of dread may hang over you all season, not knowing if you’re over budget, or should have any sense of security – all because your financial position is unknown.

Lack of a clear financial picture hampers your ability to plan. Barnabé uses the example of fertilizer, suggesting that if there’s never a review on how much was purchased versus how much was used, it becomes impossible to fine-tune future purchases and possibly save money.

Similarly, perhaps a farmer should defer certain purchases for a year but didn’t because of an unclear financial picture. This can lead to unnecessary fees on a line of credit that could have been avoided with a regularly monitored financial model.

“If there’s a tightness in the cash flow, if the line of credit is high and it’s creeping up there to the max, they can start selling crops off. They won’t know that unless they’re really paying attention and monitoring their financials.”

Check in on financials multiple times per growing season

The most prepared and stress-free clients Barnabé works with realize that more information is a net positive.

He suggests you sit down with your accountant or financial advisor to review and adjust budgets at least twice during the growing season.

There are only benefits as it provides direct insight to business health and compares actual spending against the spring outlook. With a clear plan, surprises should be minimal, especially given the costly nature of capital expenditures, input costs and external fees.

“Rather than being reactive at a year-end meeting with their accountant, farmers can update and understand where they sit financially, and maybe plan for cash outflows.”

Farmers often make sizeable purchases in December to defer taxes. However, this should only be done if you’re making an informed decision based on your farm data.

While using financial modelling to plan for the future of the farm operation, it’s important to take business, and life, highs and lows into account. Ensure you have sufficient and strategic insurance to manage unfortunate events such as a death of a family member or worker, divorce or workplace accidents. Have insurance on everything from your own home to each piece of machinery.

Overall, it comes down to understanding your debt service ratio to avoid reborrowing but not actually paying down debt.

Up-to-date financials make stronger farms

“Financial models that are regularly reviewed and adjusted can really reduce that anxiety and stress and also allow farmers to understand how they’re doing from a financial perspective,” Barnabé says. “In farming there are so many variables. A farmer can take charge of the variables through proper budgeting and help reduce financial stress and ensure financial security over the operation.”

From an AgriSuccess article by Trevor Bacque.

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