Now it’s time to examine the tools and ideas that can help take your operation’s year-end financial review to the next level. This process will help you set clear goals for the coming year and prepare your projections, as well as identify areas of strength and ones needing attention.
To begin, gather all of the operation’s financial information, and we don’t mean the records you prepare for the tax specialist or banker.
Let’s face it: There are three reasons farming operations keep financial records. The first is to satisfy tax reporting requirements. While this is important, it should not be your sole decision-making source of financial information. The second reason is to satisfy your bank’s financial reporting requirements to gain access to credit. This brings more focus on the balance sheet and collateral than the tax reports – but as it’s often a market-based analysis, it’s usually not a complete source of financial information.
Records: Managerial accounting
The next-generation manager understands that a key reason to keep accurate and timely financial records is to make better management decisions. The next-generation manager is typically not focused on cash and market-based records, but rather accrual-based earnings statements and cost-based balance sheets while also including a statement of cash flows. These statements combine to provide a clearer understanding of operational performance. The Farm Financial Standard Council website (ffsc.org) is a great resource for learning about this type of managerial accounting.
Once you have the financial information gathered, it’s time to dig in. Top-tier managers will use this information to build a trends analysis page that includes key performance indicators and ratios (Table 1).
This analysis mimics their management dashboard and includes the most impactful numbers for their operation as well as some industry-standard ratios.
Top-level managers then review the trends page and use an “onion” approach to analysis. That is, they start with the big numbers and peel back the layers to understand what’s driving them. For example, if they start with the return-on-assets (ROA) ratio, they ask whether it’s above or below the last year. How does it compare to similar operations? If it’s below their goal or expectations, they ask if it’s the numerator or the denominator in the ratio that’s driving it.
In the case of ROA, it’s earnings divided by assets. So if you’re not meeting your goals, it becomes a matter of whether you don’t have enough earnings or whether you have too much invested in assets that are not driving earnings. If it’s your earnings, then look at the earnings statement and ask: Is your top-line earnings lower than expected? Or are your expenses too high? If it’s expenses, then start drilling down line by line to see where the issue lies.
Along with top-down analysis, next-generation managers use variance reports, which compare their operation’s performance to their plan, their previous performance and their peers. Variance reports examine each line on your financial reports. The goal is to determine what is the variance to plan, to the previous year and how those variances stack up against your peers. This type of analysis pinpoints key areas you need to work on while also pointing out areas you should celebrate and continue.
The key is to be able to understand the “why” the variance exists. For example, if purchased feed costs are above plan, is it because prices are higher and you were open to the market? Or was it because you had more animals to feed and were also driving production higher? Will this change your strategy or risk management plans going forward?
A holistic approach
While it’s important to take your year-end financial review to the next level, top-level managers don’t just use variance reports at year-end; they use them monthly. Next-generation managers don’t just use these processes on financial analyses; they apply the same top-down analysis, trends analysis and variance reporting to every aspect of their operation. That is, they tie the same processes to their analysis of their production performance and risk management plan performance.
Next-generation managers are also keenly aware of their own strengths and weaknesses. They take inventory of themselves on a regular basis and surround themselves with a team that helps build on their strengths while improving their weaknesses. Top-tier managers fully understand that attitude matters, that being proactive wins while being reactive is a struggle. Their focus is controlling what they can control but being prepared for change.
While it’s easy to get caught up in the day-to-day workings of your operation, next-generation managers understand analysis time is valuable time. Investing in a sound year-end review will be a great start to a continual process of evaluation, review and adjustments that can help improve decision making and performance.
In the end, timely and accurate management-level accounting drives decision-making for the next-generation producers. If that isn’t motivation enough, next-generation managers tend to sleep better at night. Here’s to many good nights’ sleep in 2022.
Brad Guse is BMO Harris Bank senior vice president, agricultural banking. Email Brad Guse.
PHOTO: Mike Dixon.
Note: This article is provided for information purposes only. Readers should consult their own professional advisers for specific advice tailored to their needs. Information contained in this article may be subject to change without notice.
- Managing Director
- Head of Agriculture Banking
- BMO Harris Bank
- Email Sam Miller