
Work with your lender to enable accurate financial analysis and avoid misinterpretations that could impact your business decisions.
The unexpected bank meeting: A farmer’s story
Last fall, one of my favorite clients called. He had been to the bank and had come back disappointed. Over the years, he had experienced the typical troubles of any farmer but had self-corrected by making hard choices. He had good records. 2021 and 2022 were good years.
However, the bank told him that in those years he had lost nearly $700,000 in working capital and had a $1 million accrual income loss in 2023 alone.
This meeting led to a long weekend of soul searching, beating himself up and wondering what in the world had he done wrong and why was he continuing to do it. He had another business that was very profitable. Why not just focus on it and let this farming go?
Thoughts of failure ran rampant, as did thoughts of disappointing prior generations. Then he picked up the phone … and made the statement “The bank is telling me I’m in terrible shape and you tell me I’m doing fine, I don’t get it.”
Decoding the bank’s worksheets: What went wrong?
We met and started to reverse engineer the bank’s worksheets. What we discovered was that the issue centered around a lack of analysis on fixed assets.
When the equipment trade rules changed for the 2018 tax year, producers had a rude awakening regarding the impact to their returns. Assuming a fully depreciated tractor was traded, the producer showed a gain on their tax return equal to the trade value but was then able to depreciate the full purchase price of the new equipment, not just the boot.
This led to some wacky-looking Schedule F reporting, as massive depreciation amounts were used to offset gains on trades that are reported on a different schedule. This is what the bank missed.
The importance of accurate financial analysis
In two of the years involved, my client had this trade situation. He then used Section 179 to offset the gains. When doing its analysis, the bank picked up all of the Section 179 as an expense but didn’t give him any credit for the trade value gain.
When we calculated his income and working capital status using our math, his three-year trend on working capital was a total increase of $650,000 and the 2023 income was at breakeven levels and not at all a loss … which, given local conditions, was pretty darn good.
We met with the bank to discuss, and they offered up that they actually do two calculations — one with the equipment gain and one without. Unfortunately, my client didn’t have the opportunity to see the other calculation during his meeting. If he had, a long weekend may have been avoided.
However, what they also missed was the extreme use of Section 179 and whether the math was appropriate to lay it all on one year as it is for a tax return, or whether new assets should be layered on slowly like they would for financial statement depreciation.
My client had two big concerns:
- Was he being impacted negatively on loan pricing because of how these worksheets were being calculated, and
- How many people don’t ask the right questions or have the right advisors to help them through a process like this.
Beyond Schedule F: Comprehensive financial evaluation
A Schedule F is not a valid way of truly evaluating the financial success or failure of an operation. However, you must work with your lender to get the full picture.
Provide good year end information regarding inventories, prepayments and deferred contracts. Know what you owed people at the end of the year. Know the bushels and pricing in place. Don’t rely on your lender to calculate it all for you.
Too often a computer program in a back room is doing the analysis. If you don’t have all the facts in order or have good financial records, the computer program may come back with an answer that is not a fair evaluation of your farm. Will you know when the computer is in the wrong?
Consider your current-year equipment purchases as well. Is your lender using accelerated tax depreciation methods to determine your income year over year? Can you work with your accountant to provide a financial statement depreciation schedule that provides for a smoother depreciable life and a smoother bottom line?
Building a supportive financial team
Do you feel like you have someone in your corner to help you through either the hard times or the times you don’t understand? When your lender talks about working capital, is it just terminology or do you have a deep understanding of its importance?
Surround yourself with people and institutions that want to work with you for the good of all. People that are willing to educate you and have the hard conversations before it is too late. Whether it be your attorney, accountant, marketing advisor, or banker, the relationship should be one where the service provider and the producer are partners, not one working for the other.
Want to learn more? Complete the form below and we'll be in touch. If you are unable to see the form below, please complete your submission here.Contact us