If you want to start a grass-based business, the most important question is how to make the wisest use of all the financial resources at your disposal.

A balance sheet is a place to start, said Paul Dietmann, senior lending officer with Compeer Financial. “A balance sheet is a snapshot of the investment in the farm [assets] and the financing methods used [a combination of liabilities and owner’s equity]. It measures the farm’s financial position at a point in time,” he said.

In this case, it offers a starting point.

“A balance sheet documents the value of all assets and outstanding liabilities,” Dietmann said. “It allows us to calculate important measures of liquidity and solvency and shows the progress you are making in the farm business even if cash flow seems tight. It also aligns with your federal tax return, which makes financial analysis easy.”

Key information calculated from the balance sheet includes liquidity and solvency ratios, he said.

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Liquidity is the ability of the farm to meet its current (short-term) liabilities with current assets, and solvency is the ability of the farm to pay off all of its debts if it were to be sold tomorrow.

Current assets are cash and anything that will either be converted to cash or used up within a year, including crop and feed inventories, market livestock inventories, growing crops, accounts receivable and prepaid expenses and supplies.

Current liabilities are anything that is due now or will come due within a year, including accounts payable, principal due within a year on term loans, accrued interest on term loans, all principal and accrued interest on operating loans, and all credit card balances.

The current ratio is calculated by dividing current assets by current liabilities. Dietmann said the current ratio needs to be at least 1.0, preferably 2.0 or more. The farm should have twice as many current assets as current liabilities.

Working capital, which is the current assets minus all current liabilities, should be at least 15% of the annual gross farm income, he said.

The debt-to-asset ratio, calculated by the total debt divided by total assets, should be less than 50% over the long run, according to Dietmann. However, that benchmark typically isn’t realistic for young or beginning farmers. “It should be less than 75%, but some may even exceed that. It puts the farmer in a precarious position to go much higher, as they won’t have much flexibility if things don’t go as planned,” he said.

The next steps, he said, are figuring out the costs of production with an enterprise budget and estimating the farm’s monthly cash flow. To calculate the expected net return, take the expected gross revenue (per acre, per head, per revenue source) minus the variable costs and overhead costs.

Overhead costs are the expenses that exist on the farm, whether or not anything is being produced, and can include depreciation, interest, repairs, property taxes, insurance, the value of the owner’s labor and return on the equity invested in the farm.

Variable costs are the expenses that increase as farm production increases, such as the cost of feeder livestock, seed, feed, fertilizer, vet expenses, utilities, trucking, marketing, interest on operating loans and hired labor.

Although it seems variable cost calculations would be tricky, Dietmann said it is actually the overhead costs that are a bit tougher. “We need to annualize and allocate the costs of owning capital investments, also known as ‘economic depreciation,’” he said.

Start by estimating the useful life of capital investments, including each piece of machinery, the life of perimeter fencing, buildings and titled vehicles.

For example, a 40-acre grazing operation might have a perimeter fence at a cost of $9,600 with a life of 20 years. $9,600 ÷ 40 acres ÷ 20 years = $12 per acre. Add the capital costs of other pasture improvements such as a watering system, interior fence, an energizer, etc., and you could end up with $28 per year of overhead costs to build into the enterprise budget.

“Let’s say that a beef-enterprise budget shows an estimated net return per head of $241,” Dietmann said. “That doesn’t mean you can multiply $241 x 40 head and assume you will earn $9,640. An enterprise budget is an estimate of profit, not a prediction of cash flow. It’s very important to go a step further and build a month-by-month cash flow projection for the farm. You want to know ahead of time when cash is likely to be short. You also want to know how much cash is likely to be in the farm’s checking account at the end of the year.”

Other useful tips Dietmann offers to beginning ag producers include:

  • Build and maintain a credit score above 670.

  • Reduce and eliminate credit card debt.

  • Don’t be too quick to leave off-farm employment.

  • You can never have too much working capital, but you can often have too little.

  • Everything will take longer than you think.

  • Don’t add a second or third enterprise before mastering the first.

  • Update your balance sheet every year.

  • If a lender turns you down, there are usually good reasons. Listen to him or her and proceed with caution.

Dietmann said to remember that, “Can I get a loan?” and “Should I get a loan?” are two very different questions.

“Lenders want to know that the cash flow will cover all operating expenses, family living costs, loan payments and still have enough cash to replace the stuff that rusts and rots and be able to build some working capital,” he said.  end mark

Dietmann presented “How to start a grass-based business” at the 2020 Grassworks Grazing Conference held earlier this year in Wisconsin.

PHOTO: Getty Images.

Kelli Boylen is a freelancer based in northeast Iowa.