Don’t Fool Yourself – Why Agriculture has Still Not Caught up on Financial Management
Little known fact about me, I like conflict. Whether in my personal life or business life, getting comfortable with the uncomfortable has always been a skill of mine. Not to say I don’t have emotion; I just tend to thrive off of tension and it actually makes me a better decision maker. This leads me into the story that serves as the basis for today’s blog..
I remember the Zoom call, because once again, I like conflict. I had one of my mentors, a leader in the agriculture industry on business practices, on the call with a few of the larger accounting firms in Canada. The discussion was based around accrual versus cash accounting, and how their clientele was not using cash like the bottom percentages of the industry were still doing. This is the good part, he asked how many of the farms were on accrual before the accountants made the adjustments. The answer, “next to none”.
“Well then, your clients are not accrual, and that’s the problem.”
Can you imagine if Walmart did not have accrual accounting throughout the year. No concept of inventory management, no concept of outstanding receivables from stores or payables to suppliers. Not actually knowing if they were profitable until after year-end. Quarterly earnings reports for public companies would be impossible, how would the stock market react to a company saying they are not using accrual accounting? Yet, in primary producer agriculture, where revenues and equity are into the multi-millions, we still rely on cash accounting throughout the year when making decisions.
Now, I won’t be too hard on producers today. The banks and accountants are the real adversaries in this fight. Up until agriculture became sexy (the definition of sexy here being huge land equity and high profits), neither occupation really paid attention to it. In fact, I would argue that the government didn’t jump on this train until they started realizing the tax dollars to be made through carbon sequestration, multi-generational rolls, and environmental practices. Now it is getting scary as they see the true worth of primary producer wealth. But back to the blame, before the last decade banks required minimal due diligence from farms on financial statements or even net worth statements. As I have said many times before, my dad used to provide a net worth on looseleaf in order to substantiate his loans and retail credit for the following year.
From the accountant perspective, they make more money if the client does not know what they don’t know. I can be upfront, a significant portion of my annual bills to clients was fixing the bookkeeping, making the accrual entries, and then filing the tax and creating the financial statements. If all the farms could prepare their own accrual financial statements, I probably wouldn’t have made the revenue generation for the firm that I did. In fact, being a CPA and preparing the financial statements for Hebert Group today, saves us a ludicrous amount of accounting fees per year. I don’t touch tax though, because I suck at tax (I’m pretty clear on my flaws these days).
So why does this even matter to the farmer? This seems like a banking and accounting problem at best, not a day-to-day operational problem for our operations. If it does not make me more money or save me on costs, why should I care? The reason is simple. Financial management should be one of the key aspects of your business. The reason your accounting fees are much higher than your wages to your tractor driver are because the value-add is higher. Anybody can operate a drill these days, not everybody can make multi-million-dollar decisions everyday.
How to break it down:
Cost of Production
I truly love when farms tell me their cost of production. For many, it identifies the true business acumen of their operation. Most times I know within seconds whether they have any financial fluency, or if they are purely production and operators. This is a skill based on experience and years of reviewing thousands of financial statements. There is a number that is correct, and then there is the farmer number most times.
I also love the buzzwords used in analysis. Amortization is not a cost, principal payments are an expense, I don’t take anything out of the business for personal. These are all things I hear regularly that are bricks in the wall of understanding the cost of production. Yes, amortization is a cost as I know what people are paying each time they trade equipment. No principal is not an accrued expense, it is a cash cost and much like your mortgage on your house it is paid using after-tax dollars from profit. And yes, personal drawings are an expense even if your accountant keeps your personal tax in the lowest bracket. You may not pay tax on the Malibu boat you bought, but it was paid from the corporation I promise.
Analyzing the true cost of production is one of the most important parts of my business. Revenue generation relies on yield which relies on external factors such as weather and growing conditions. Costs rely on management which relies on internal factors such as “how pretty the new combine looks in the yard”. This is where I find the most useful part of our consulting business, holding farms accountable to their cost budgets.
With the increase in costs on equipment, fuel, crop inputs, carbon tax on utilities, and just about every other thing you touch, the analysis of budget to actual throughout the year is important. This is why accrual accounting is important. If we don’t track expenses on the accrual basis, we don’t know where the farm is actually at during different periods of the year. I have seen many operations that have cash in the bank throughout the year, not so many actually made money before the current commodity boom.
Growing Crop
I also love that most operations speak in yield, not margin. I need to grow 35 bushels on average of canola to break-even. Although this is a great metric as it is quantifiable, it also does not consider pricing changes, expense overages, capital costs, and just about every other thing in business that matters.
When I worked in public accounting, I needed to work in auditing for a certain amount of hours before I could get my designation. This was where I truly saw most of my accrual accounting and big corporation processes. In order to value inventory correctly, an organization needed to track and revalue based on market and cost throughout the year. What percentage of producers actually record growing crops throughout the year or make changes to inventory valuations throughout the year? It is most often the largest account on the balance sheet, but the majority of operations never value it correctly until the accountant gets it.
Why is this important? On our farm a $1 drop in canola this year would reduce our profitability by more than $500K. Or a drop in expected canola yield by 1 bushel around $250K. With numbers this large, not updating yield predictions against our “actual” cost of production throughout the year would make future decision making difficult. Can we afford a new investment? Can we upgrade our capital? What about land expansions? This is truly how we make our decisions, based on real-time, accrual, and accurate financial information.
There are many other areas of accrual accounting we could discuss, but these are the main parameters that most operations overlook. In fact, these are the main parameters that most banks and accountants overlook throughout the year as well. As an industry we are really strong at getting the numbers right after the fact. This is also why as consultants we try to move the banking industry forward by pushing projections and data throughout the growing season rather than high accounting fees for assurance work such as review engagements or audits. Making sure the numbers are iron clad four months after year-end really is not that important. Getting data throughout the year that will affect lending and operational decision making is crucial.
When we don’t fool ourselves, things tend to work out better in the long run.
