As advisors, we see many business and farm financial statements through out the year.  Most of the successful farm businesses have several key financial ratios in common.  Even though each farm business is different, it is surprising how these ratios tend to be in the same range for each business.

These key ratios that we look at are as follows:

• Current Ratio – This is the ratio of current assets comprised of cash, inventories and receivables divided by current liabilities comprised of short-term notes payable, accounts payable, accrued liabilities and current portion of long-term debt.  This ratio determines how much of your assets will be available to pay off the debts owed over the next year.  It is important to include any long-term debt that will be paid off in the next year.  This ratio should exceed 2:1 and for most successful farm businesses, it is usually over 3:1.

• Net Worth to Debt – This is the ratio of your farm net worth divided by the total debt of the farm.  The higher the ratio the less your farm is leveraged.  Most successful farms will have a ratio that exceeds 2:1 and in most cases will approach 5:1.  A starting farmer’s ratio will usually be much lower than a long-term many generation farmer.  This is one of the ratios that bankers will always put the most importance on.

• EBIDTA – This is your farm earnings before interest, depreciation, taxes and amortization.  The reason this ratio is important is that it places each farm operation on the same level, i.e., you are able to compare a farm bought for cash to a farm bought with debt.  This will let you know for each farm or farm unit what income is being generated by the farm.  This income should always have an expense component for the farmer’s salary to make it comparable to other businesses.  The ratio of EBIDTA to net farm sales will vary greatly depending on the type of farm crop grown, but in general, we should see a ratio that exceeds 20% or more.

• Machinery costs to sales – This ratio seems to be one of the best ratios in determining how profitable a farm is.  The lower that a farm operation can keep this number, then this farm will usually end up in the upper farms in profitability.  Some farmers will lease new equipment each year while others will keep the same farm iron forever, the key is to keep this ratio as low as possible and still get the crop grown and harvested.

I have given you four of the key ratios that I see.  Have you computed yours and are there others that you use on an annual basis.  Let me know!

Facebook has a game called Farmville that has become very popular.  When my wife first started playing the game, I almost thought I was going to have to get her some treatment for her addiction.  I would constantly get messages from Facebook asking me to do something for her Farmville game.  The first couple of times, I did what it asked and after that, I decided was too much work and stopped doing it.

I have found that this game seems to appeal to women more than men.  I am not sure why that is true since I like all things about farming, but I think the main reason for me, is that it is not real farming.  The process of planting, growing and harvesting a real crop has much more appeal to me than a game.

This post is simply a reflection of my opinion.  I am sure there are others who disagree with me, but I know that millions play the game.

As advisors, we are actively involved in succession planning for farmers and other businesses.  This is usually a long process and will change over time and as the generations involved grow and mature, their goals will usually change.

There are three main goals related to this planning:

1. Protect – The primary goal of any succession plan is that both generations involved are still protected in the following areas:

                Financial – Are the owners transferring the business still protected from a financial standpoint.  Did they create enough retirement and other assets outside of the farm to protect their retirement income

                Operational – Does the succession plan provide protection from operational issues such as the new generation being ready to take over the farm operation.  Nothing will ruin a farm family quicker than the next generation taking over sooner than ready.

                Entity – Does the succession plan provide for legal and entity protection.  Are they taking advantage of limited liability companies, corporations and trusts where appropriate.

   2.  Provide – Once protection is taken care of, the next step is to provide for both generations.  Is there enough cash flow to provide a normal living standard for both the current generation and the new generation.  If not, how will the farm family address this.  Will they have a spouse work off the farm or one of the heirs.  Will they do custom farming, etc.

  3.  Prosper – After the farm family is protected and provided for, then comes the time to prosper.  Does the farm family have enough management time and experience to expand the farm operation with more acres.  Or do they have excess machine time and people to do custom farming.  Each farm family has different goals when it comes to the prosper stage, but they must always remember to protect and provide first.

What stage is your farm operation in?

For an online video presentation of my “chalk talk” on this subject on the AgDay special “The Legacy Project” go to this link.  Here you will see a farm family discussing their succession plan with Kevin Spafford, host of The Legacy Project” and myself giving him advice.  Later in the show, Kevin and I have a chalk talk on the three P.

I hope you enjoy watching it and let me know of any future discussion topics that you would like to see addressed.

I have enjoyed doing my blog for about a year now and have now started to see some farmers using a blog to communicate with their landlords, neighbors, bankers and others that might be interested.

Reading the latest issue of Successful Farming, I noted an article on the Martin Family Farms in Logan County, Illinois.   The title of the article was “Communication keys their success”.  It was a very good article on how communication between parents and children, employer and employee, and tenant and landlord are extremely important to a successful farm operation (or any business).

Doug Martin decided to create a blog to keep his landlords apprised of what is happening on the farm.  Many of his landlords are located in very distant states such as California.  By using the blog, the Martin’s keep their landlords informed and share what is happening in a real-time efficient manner.  “Anything we can do to communicate to our landlords that they are a part of us, helps them feel a part of the operation.”  I think like most things in life, landlords would rather be part of a good farm community than simply leasing their land each year to the highest bidder.

I would strongly suggest trying to do a similar blog.  I think it would well be worth the effort even if you are not computer savvy.

Here is the Martin Family Farm blog.

Elizabeth Williams from the DTN/Progressive Farmer had a very good post on the five steps needed for the farm transition.  The article dealt with a young farmer who lost his mother due to brain cancer.  The estate did not owe any current tax since the assets passed free of estate tax to the husband, but if he had passed away that same year, they would have had a major estate tax problem.

The five steps mentioned were:

1. Get Experienced Legal Help – Find a good agricultural estate tax attorney (or a good farm cpa) to help design an estate plan to meet the unique needs of the farm estate plan.
2. Recognize that your Paperwork will Increase – If your estate goal is to reduce estate taxes, transfer property to the next generation with the least income/capital gain tax and divide your assets equitable among your children, that usually means multiple farm entities.  This requires separate bank accounts, year-end meetings and compliance, etc.  However, to do it right, more paperwork will result.
3. Allow the Next Generation to Control or Own Something that is “Theirs” – It is important for the children to have some skin in the game to promote the pride of ownership.
4. Listen and Talk to Each Other – No one can read your mind.  Not being transparent can cause a multitude of problems.  “A lot of animosity can build up when off-farm family members don’t know what the deal is. What is the on-farm sibling getting?”
5. Respect the Division of Labor – The most successful family farm operations have distinct, complementary divisions of labor.  As I said on my TV taping, find what each member does best and let them do it.  The farm will be better off and the family member will feel best about themselves.  Part of that comes from clearly defining the expectations that go along with ownership and management of the farm.

The cost of not planning can be very high!  Even a 500 acre farm can generate a large amount of estate tax starting in 2011 if no changes are made to the estate tax laws.

For a primer on “Transferring the Farm”, go to the University of Minnesota’s Center for Farm Financial Management.

I received two excellent comments on my post from Monday of this week regarding the cost to some farm families of not having an estate tax for this year.  The comments had additional information which is all applicable for this year.  The main intent of my post was to let farm families know that without proper planning, an estate in 2010 can cost your farm operation a large amount of current or future taxes.

Also, the key problem with the 2010 estate law is that effective January 1, 2011, it reverts back to the law in effect in 2001.  This means that all estates larger than $1,000,000 will be subject to federal estate taxes.  A quarter section of good farmland can exceed this amount alone.  Congress needs to take action and soon to correct this, or thousands of farm families will be much worse off on January 1, 2011 than they were on January 1, 2009 or 2010.

I will keep you posted and keep sending me the comments.

I enjoyed doing the show, but as my wife would say, don’t plan on changing your day job.

Most farmers are assuming that since there is no estate tax for 2010, that this must be a good thing for all taxpayers.  The reality is that many farmers may end up paying more in taxes than under the law in effect for 2009.  This is due to the fact that carryover basis will no longer be in effect for many estates.

Under the old law, when a person died, all of their assets were revalued for income tax purposes  based upon the value at the time of death.  Then when the heirs sold the assets, this was the “cost” that they could use in determining their gain or loss.

For example, suppose, a farmer died owning equipment that was worth $1 million dollars that had been fully written off.  Under the old law, you could step up the value to $1 million dollars and depreciate it over 5 to 7 years.  If instead, you decided to sell the farm equipment for $1 million immediately, there would be no tax owed.

Now, when you inherit the equipment, you get no step up in basis, and when you elect to sell the equipment, the gain will be completely taxable.  Also, this sale will not qualify for capital gains treatment, therefore it will be subject to ordinary income tax rates.  At a 35% bracket, this would result in owing $350,000 of tax.

Therefore, due to not having an estate tax, we went from (1)  complete step up in value to date of death value, (2) no estate tax being owed for all estates under $3,5 million, and (3) full write of assets over time as depreciation against other income  to owing $350,000 in income taxes.  This does not sound too good to me. 

I am hoping that Congress gets their act together and fixes this, but I am not too hopeful.  I will keep you updated.

For those people living in rural areas, the smells associated with hogs, cows, etc. can be a nuisance.  Usually most people grin and bear it, however, there are many times when they try to do something about it.

The High Plains Midwest Ag Journal recently reported on a civil trial filed in Kansas City regarding the hog odors from a large commercial hog operation about 80 miles north of Kansas City.  This operation usually contains about 80,000 head of hogs and encompasses over 2,000 acres.  Fourteen rural neighbors had already received $100,000 apiece from a 1999 lawsuit, however, they have taken Premium Standard Farms back to court arguing that these payments are not enough to compensate them for the continuing odors.

The company argues that they are not suffering “substantial impairment” from the odors.  They agree that hogs stink, but it does not meet the qualifications of a nuisance under the law.

Kansas City attorney Charlie Speer has won over $10 million from Premium Standard and its affiliates since 1999 on these types of cases.  In 2009, he indicated a lawsuit that was settled for $1.2 million will “set the bar” for future cases.

PSF attorneys contend these lawsuits are driven only by money and are causing damage to the local ag economy.

I believe that both sides have some merit to their cases.  These smells can be overpowering when you have that many animals in a small area, however, most people living in farm country usually know this when they move there.  I think, however, that these large operators sometimes believe it is cheaper to just settle the lawsuits than to try to fix the problem which can cost substantially more.

The Federal Reserve Bank of Kansas City puts out a quarterly review of credit conditions in their region.  This region covers Kansas, Missouri, Nebraska, Oklahoma and most of the Mountain States.  I try to give you a recap when it comes out since the information is both timely and interesting.

The most recent report for the fourth quarter of 2009 showed that average farm values in the region were up about 3% over the same time in 2008.  Kansas, Missouri and Oklahoma showed more than a 3% increase, while Nebraska was only marginally higher and the Mountain States actually showed a price decrease.  This decrease was primarily due to the larger concentration of livestock operations in these states which have not fared well over the last few years.

The bank indicated the strength was due to two primary reasons:

• Rising farm income due to both stronger prices at year-end and higher yields, and
• Small supply of farmland available for sale

For the farmland that did sell, more of this went to other farmers rather than investors.  Residential development is almost at a standstill right now and the recession has put a crimp on people being able to buy farmland for recreational purposes.  Also, the bankers noted that more farmland was purchased for cash during the quarter.

Many of the bankers expect farmers to purchase more capital equipment during 2010 than in 2009.  Livestock prices did move higher during the quarter, but they remain slightly under break even levels.

With the price decreases in January, 2010, it will be interesting to see what the next report brings.