Good harvest and good prices have been achieved by many this season. Seasonable fall weather has allowed most to complete fall tillage in preparation for the 2022 crop.
So, what is next? High crop input cost for 2022 and apparently the lack of availability for some inputs may be a great cause for concern. What’s next is the evaluation of 2021 and planning for 2022. To begin this process, I would suggest the following steps: income tax planning; developing a capital purchase plan for the next three or more years; creation of the Dec. 31 balance sheet; analysis for the whole farm return on investment and a complete enterprise analysis; and cash flow projection for 2022 and perhaps beyond.
Income tax planning is essential. Farmers, as cash taxpayers, have a lot of methods to control and balance the amount of tax paid each year. Work with your farm business management instructor and/or your tax accountant to review options including prepaying for 2022 inputs, deferring income or using 179 deductions (remember not to use this if you have a loan on the item). If you are planning on a major capital improvement project next year, it may work in your best interest to reduce your taxable income as much as possible this year via prepaying, etc. This should allow you to increase cash (working capital) in your bank account early in 2022.
One other item to consider in tax planning is the Employee Retention Credit. If you qualified in 2021 for this credit and plan to apply for the funding early in 2022, the ERC credit is taxable in 2021 even though you may not get the money until 2022. For those operations with several employees and potentially a sizable ERC credit, this could have a significant impact on your income tax plan. The ERC funds are taxable in the year of the expense.
It is important to create a tentative 2- to 3-year (or more) capital replacement and improvement plan. Determining how much the cash flow can handle with the volatile market swings is crucial to continued success and growth. Machinery will depreciate (at least on the balance sheet) 10% or more on an annual basis, so machinery replacement is critical to balance sheet growth. However, in an era of high-priced machinery, it may be difficult to come across good deals. On dairy farms, my benchmark is to keep the loan and lease payments under $2.50 per hundredweight of milk. Figuring out where you are (debt payment per cwt.) and where you will be if you make a capital purchase is an excellent exercise in helping make that decision.
The balance sheet is likely the single most determining factor to your farm’s profitability. Measuring and tracking equity (net worth) growth year-over-year, at the same time of year, is essential for setting trends. With inventories (especially feed/grain) varying from month to month, a balance sheet at various times of the year could give undesired results when comparing trends. I suggest using reasonable market values on all grain, forages and market livestock. Valuing corn, for example, at $6 on the balance sheet and then eventually selling it for $4.50 will likely give a false impression of real gains. My preference, if the commodity is not contracted, is to use a valuation number closer to your cost of production and take the gain on your balance sheet when the real gain is recognized at the time of sale. Some will disagree with me on that statement, and perhaps I am too conservative, but this method will result in true equity gains being realized when they occur.
A farm financial analysis should be done on an annual basis. It allows you to see the return on your investment in various categories as shown below. The Finpack analysis system used by the Minnesota Farm Management program calculates:
– Liquidity: Compare the beginning to the end of the year. It measures the financial position of the business to meet short-term obligations.
– Solvency: Change in net worth. The ability of the business to pay all its debts, if liquidated.
– Profitability: Including net farm income (income – expense – depreciation), rate of return on assets, rate of return on equity and an operating profit margin.
– Repayment capacity: Measures the capacity of the business to repay debt and replace assets.
– Efficiency: Measures the strengths and weaknesses of cost control, including operating expense ratio.
In addition, doing an enterprise analysis (dairy, corn, corn silage, hay, etc.) allows you to see the profitability and cost of production for each area of your farm business. I encourage you to connect with a farm management person or your banker to have these discussions on the financial performance of your business.
Cash flows are merely a financial projection of the upcoming year. It is important for the banker, but more importantly, it helps you have a road map and mentally process what your intentions will be for the upcoming year in terms of capital purchases, sale prices and net profit. I would challenge everyone to review this plan more frequently throughout the year to see how their business is progressing.
If you have questions about any of these five areas, contact your local farm management person or your banker.
    Tom Anderson is a Farm Business Management faculty member at Riverland Community College.