Chapter FourManage ItBusiness Management for the Farm

Goodfoot Farm

As you begin to implement your plans and create your farm business, business management will be one of the most important factors determining your success. Whether your interest is in turning a huge profit or making just enough to live on, sound business management is key. Without money to pay for the up-front expenses, it is difficult to get much beyond the planning stage. Without money available through the season for ongoing expenses, you will have a hard time keeping the operation functioning. And without any financial reward at the end of the season, you will be challenged to keep the business going long term.

Business management may seem complicated or intimidating, but with training and practice, all farmers can adopt successful business management practices. Think of business management as a process of continuous improvement. A simplified outline of that process is shown below and includes the following steps:

1. 1. Plan and set financial goals for the business. (You began this process in chapter 1, “Dream It” and chapter 3, “Sell It”).
2. 2. Implement plans, grow crops, raise livestock, and create, market, and sell your product.
3. 3. Keep good records of your activities, costs, expenses, sales, income, and other important information.
4. 4. Assess and analyze the results of your efforts.
5. 5. Integrate that information back into the planning process as you build your farm business in the future.

The purpose of this chapter is to help you get started in this learning process.

By the end of this chapter, you will:

• Understand the role that different types of budgets have in farm business planning and be able to create budgets for your farm business.
• Know what kinds of records you need to keep track of farm finances.
• Understand the various types of accounting systems and implement an accounting system appropriate for your farm business.
• Be able to create basic financial statements for your farm business that help you monitor income and expenses, manage your cash flow, and assess your financial position.
• Know what kinds of financing options are available to you — and be able to assess those options based on your needs.
• Be able to analyze the differences between what you planned for and what actually happened, and how to use this information to make decisions that allow you to reach your financial goals.

Managing the financial side of your business is a big topic. While we do not cover all aspects, by the end of this chapter you should have a good foundation to work from, as well as ideas for where to look for more information when you want it.

Business Planning Process

Goal Setting and Budgeting

Business management begins with establishing some clear financial goals for your farm business. You may want to revisit some of the goals that you identified earlier in chapter 1, “Dream It” — particularly your profit/income goals. Even if you plan to keep an off-farm job in the near term to support your family living expenses while you grow the business, you still must think about how much profit you need each year to cover capital improvements. If your goals include eventually making enough income from the farm business that you can quit your off-farm job, now is the time to get clear on how much you need to make to cover your personal expenses.

Budgeting for Income, Expenses, and Profits

Once you have clearly defined your financial goals, you can look at what you are planning to sell, what that product is going to cost to produce, and what price you can charge in the market. This information will help you determine if and how you will be able to meet your financial goals. To reach those financial goals, you need a budget. Simply put, a budget is a plan expressed in dollars; that plan is based on estimates derived from the best information on hand at the time it was created.

Income

Your marketing plan (see chapter 3, “Sell It”) should include a sales plan that projects how much of your product you plan to sell, when it will be sold, and approximately how much money those sales will generate. These sales projections are the foundation of your budget for income — the money you expect to bring in from the crops/products you sell over the course of the season. At the start of the growing season, it is not possible to be exact about these sales figures; it is okay for the budget for income to be based on your best estimates. Conducting some basic market research will help you improve the accuracy of those estimates. Over time, as you keep track of how much you actually sell of each product, the accuracy of your estimates will improve. Pricing can be particularly hard to estimate. When you are just getting started, you will rely primarily on market prices to determine what you can sell your products for (“competition-based pricing”). Eventually you will be able to incorporate some information about your own costs of production into your pricing decisions (“cost-based pricing”).

The chart below shows a sample sales budget for a small farm selling through three different channels: CSA, farmers’ markets, and direct to restaurants. CSA sales are projected based on the number of shares sold per week. Projected weekly sales of individual crops at the farmers’ market and to restaurants are also listed. This budget shows the expected income for each product the farm is planning to sell, along with the total income for the whole farm.

Sample Sales Budget

Computer Spreadsheets

The sample sales budget was originally created on a computer spreadsheet using Microsoft Excel. Depending on how you set up your spreadsheet, you can have the computer calculate incomes for you and have it recalculate when you change scenarios. For example, in the sample sheet, the numbers in the total income column are generated by formulas. If you change any of the numbers in the quantity, price, or weeks column, the total income number updates automatically, so you can instantly see how changes in your sales plan change the total income projections.

Expenses

After you have put dollar figures on your sales plans, it’s time to identify how much it will cost you to grow the crops or raise the livestock you intend to sell. It is important to distinguish between operating expenses and capital expenses.

Operating expenses refer to costs for services or supplies that are used up within a year — costs that you incur as you implement your production plan. Examples of operating expenses include:

• Labor
• Seeds
• Plants
• Fertilizer
• Livestock feed
• Electricity
• Fuel

Capital expenses are costs for larger, more durable items that you do not expect to use up in one season. When you are first getting started, you will have a number of capital expenses as part of your start-up costs. Although this will not be the only time that you spend money on capital expenses, these costs will probably be much higher in your first years on the farm. Examples of capital expenses for a farm business typically include assets such as:

• Tractors and implements
• Vehicles
• Buildings for storage and/or packing
• Irrigation systems
• Propagation houses and high tunnels

Capital expense assets are typically in use for multiple years. To evaluate the profitability of the business over time, the cost of purchasing the asset needs to be distributed over the years that it is in use. Doing so aligns these costs with the income (revenues) that it helps to generate. If you do not distribute the expense over multiple years and instead treat the entire cost of purchasing an asset as an expense in the year that you purchase it, you will skew profitability — making the business look far less profitable than it really is in the first year, and making it look more profitable than it really is in subsequent years.

You can account for capital expenses (assets) through accrual or cash accounting. Accrual accounting is based on the matching principle, which requires that income and expenses be in alignment. To achieve this alignment, capital expenses are distributed over their useful economic life using an accounting tool called depreciation. In pure cash accounting, the cost of an asset is expensed in full when the asset is purchased, even though it will help generate income for years to come. You will learn more about these two different systems for accounting in the Record Keeping section of this chapter.

The sample expense budget corresponds with the sample sales budget below. Projections for annual operating expenses are listed by cost category, along with the expected total expenses in each category for the whole farm for the year.

In the sample expense budget, labor costs (hourly wages and/or salaries of employees) are included in the payroll category. This category includes an estimate for payroll taxes (often 10 to 20 percent above the wage), and, depending on the status of your hired labor, you may need to pay for workers’ compensation insurance and unemployment insurance. Any additional benefits for workers that the farm provides, such as health care or retirement, would also be included in payroll expenses. Contract labor or services hired out should be accounted for in a separate expense line. The business structure you choose for your farm (we will cover this in chapter 6, “Keep It”) will determine whether you account for the cost of your own labor as part of your payroll expenses or pay yourself out of your net profits.

Note the depreciation expense of $4,000 in the sample expense budget. Fuel costs and the cost to repair and maintain assets are not included as part of depreciation expenses — they are each their own separate expense category. Likewise, the cost of equipment rental is in its own expense category (not under depreciation).

Depreciation

The process of distributing the cost of an asset over its useful life is referred to as depreciation. Depreciation accounts for the decline in value of the asset over time and provides a more accurate picture of profitability from year to year.

There are a number of ways to calculate depreciation. As a business expense deduction on your taxes, depreciation is regulated by the IRS, and the methods for calculating it are not necessarily the best ways to evaluate business profitability.

For evaluating farm profitability, the simplest approach is to use straight-line depreciation, where the cost of an asset is distributed evenly over its useful life. To calculate straight-line depreciation, divide the original purchase price of an asset by the number of years of its expected useful life. If the asset is expected to have any salvage value at the end of its useful life, this value is first subtracted from the original purchase price. For example, a $2,100 rototiller that is expected to work for 10 years and have a salvage value of $100 would depreciate at $200 per year, so for each of these 10 years, a $200 depreciation expense would show up on the farm’s operating budget. This helps you to align the costs of an asset with the revenues it helps to generate.

There are more complicated ways to calculate depreciation that may give a better representation of the annual cost of owning the equipment. If you are interested in learning about these methods, look for information on “economic depreciation” or “book depreciation” methods and not tax accounting methods. (Be sure to consult with a tax accountant to find out the best way to handle depreciation for your taxes.)

There are no hard-and-fast rules for deciding which equipment to calculate depreciation for, but the general concept is that you want to spread out the accounting for large expenses that represent multiple years of use. Tools that cost less than a few hundred dollars are usually expensed in the first year for the sake of simplicity. For example, you would probably not depreciate the cost of a $50 hoe, even if you expect to use it for many years.

The cost of renting or leasing land is considered an operating expense, as is interest paid on a mortgage, since these are essentially used up in one year. If you buy land, that cost is not treated the same as other capital expenses. Because land typically holds its value or increases over time and does not have a limited life, the cost to purchase land is not accounted for as an expense at all.

While the sample budget provides a starting point for identifying some of the types of operating costs you need to plan for, it is by no means comprehensive. Nor are we suggesting that the amounts shown in this budget are typical and that they can be used for your farm. Remember, you should plan for the operating costs that correlate with your production plan, and your production plan should be created to achieve your sales plan.

During your first years of farming, you will need to estimate how much labor and other inputs are required to grow or raise the products you plan to sell. As you gather more information and become more experienced, you can update these numbers to better represent your true costs. To prepare an expense budget, you can use these sources:

• Sample budgets (also called enterprise budgets) from educational sources
• Information collected from other farmers
• Seed catalogs
• Quotes from suppliers

Over time, your own actual farm records of costs will likely be the best resource for estimating future costs.

Profit

Once you have budgeted for income and expenses, you can calculate the amount of profit based on those budgets. The sample income, expenses, and profit budget shown below brings together the sample sales budget and the sample expense budget below. The total profit is simply the amount that remains after subtracting your expenses from your income.

Compare this profit to the profit goal that you identified in the beginning of this chapter. If the total profit does not match your profit goal, you need to make some adjustments to your sales plan and your production plan to increase your projected income or decrease your projected expenses — or both.

Sample Expense Budget
Expense Category	Expense Amount
Payroll	$46,440
Soil amendments	$4,000
Seed	$3,000
Greenhouse supplies	$1,500
Fuel (on and off farm)	$900
Utilities	$1,450
Repair and maintenance	$500
Equipment rental	$250
Packaging	$150
Market fees	$300
Insurance	$1,000
Land rent	$2,200
Depreciation expense	$4,000
TOTAL EXPENSES	$65,690

Sample Income, Expenses, and Profit Budget
Total income	$86,576
Total expenses	$65,690
TOTAL PROFIT	$20,886

Farmers Share Their Experience

Production Costs and Profitability

Production costs and the price you get for your product in the market are two major factors in determining your profit margin. As you have learned in this section, there is a real balancing act with both of these factors. Here, Beth Hoinacki and Carla Green share how they are addressing production costs in their own farm businesses. Note the challenges they are dealing with and how each farmer is trying to address those challenges. Note in particular how labor costs figure into the calculation — not just hired labor, but the farmer’s own time.

Beth Hoinacki, Goodfoot Farm (see profile)

I have a time sheet for my employees. When they get to work, they sign in with the time. When we take a break at lunchtime, they sign out for their lunch break. They also write down an approximation of what they did during those hours.

For example, the person who worked for me this summer spent 1¹⁄₂ hours working in the blueberries, prepping the field; 1 hour hilling potatoes; and 1 hour weeding this particular block, maybe the onions. The key thing is that I need to do that for myself, too. I need to write down in my pocket notebook that I just spent an hour wandering around making a to-do list. That’s important. That’s your management overhead cost, and it has to be accounted for somewhere.

My challenge for this next year is to track my own time and have my husband track his time so that we can establish a crop budget and track production costs. I’m basically setting my prices according to the market, not what it’s costing me to produce them. I think you have to take both of those things into consideration. Getting a handle on the production costs is key.

Goodfoot Farm

Carla Green, Sweet Home Farms (see profile)

This is not an easy business to make profitable. You have to look at your costs and your production across the board, and the only way to do that is to keep good records.

When we do our financial planning, we include payment for ourselves to show how much money we’re really losing, which is kind of distressing. But it’s what you have to do. Once a year, we set aside time to plan for the following year’s expected income and expenses. In our projections, we include flock and herd management as well as breeding herd statistics. We use QuickBooks, and it took some time to set those up those accounts, but once set up, they were enormously useful.

For us, labor is a huge overhead cost. We made hay, but we stopped when we realized it cost us as much to make the hay as it cost to pay somebody else to make it. So then we spent that time we would have spent making hay going to farmers’ markets to sell, which we felt was a better use of our time.

When we started to do our economic analyses, we discovered that it cost us about twice as much to raise a calf here as it does to raise a calf in central Oregon, so we partnered with a farm in central Oregon. We send our cow calf operation over there, and then we bring the yearlings back here to finish when we have good grass.

Sweet Home Farms

Budgeting for Cash Flow

Even if your budget for income, expenses, and profit shows that at the end of the year you will bring in enough income to cover operating expenses — and hopefully have something left over in profit — you could still find yourself short on cash over the course of the growing season.

Cash shortfalls are primarily a matter of timing. In your first several years of farming, you will likely have large cash outflows before seeing any cash inflows. Typically, you will need to buy inputs like seeds, soil amendments, and feed and pay for all the labor required to raise your products before you get a single dollar in sales.

To plan for cash shortfalls, you can create what is called a cash flow budget. A cash flow budget identifies the amount, and the timing, of cash inflows and cash outflows. Cash flow budgets are often developed on a monthly basis but can be created for any time increments that are useful for you.

The key thing to remember is that a cash flow budget is focused on the actual amount of cash going into and out of your business, and the timing of these cash flows. If you are using credit to pay for expenses, account for the cash outflow when that credit is paid for — not when the item was actually purchased. For example, if you are looking at a monthly cash flow budget and you expect to buy fertilizer using a credit card in March but the credit card bill will not come until April, you would record that cash outflow in April.

The cash flow budget below shows the amount of cash on hand (starting cash) at the beginning of the month and then lists all the cash inflows and cash outflows that occur in that month. At the bottom of each column the cash balance (ending cash) for the month is shown, which is equal to the starting cash plus the cash inflows minus the cash outflows. The ending cash for one month becomes the starting cash for the next month.

In many ways the sample cash flow budget looks similar to the sample income, expenses, and profit budget. Many of the same income and expenses that show up on the budget for income, expenses, and profit show up here — there is simply more detail here about the timing of this income and these expenses.

A few key differences are worth noting: the sample cash flow budget includes a loan payment and an owner’s draw. These are not expenses; they are cash outflows that you need to plan for. A loan payment is not an actual expense — it is a delayed payment for some other expense, typically a way to make the timing of cash flow work better. Any interest on loan payments is an expense. Owner’s draws are also not an expense; they are just the owner taking money out of the business, which reduces the owner’s equity. Owners also can, and often do, put money into the business (perhaps to buy a piece of equipment). Similarly, that is not considered income — it is a contribution to owner’s equity.

Another difference is that cash outflows for capital expenses, such as buying equipment and infrastructure, are included in the cash flow budget. Depreciation, on the other hand, is not included because, although it is an expense, it is not a cash outflow. Remember: in the income, expense, and profit budget, the goal is to compare the income that comes in to the expenses that were required to generate that income — so the cost of assets are distributed over the life of the asset, as a depreciation expenses. In the cash flow budget, the focus is on the actual amount of cash that comes in and out the door — so the full cost of the assets are included as a capital expense.

When your cash flow budget reveals potential cash shortages, you should plan for how to address those shortfalls.

Sample Cash Flow Budget

Farmers Share Their Experience

Cash Flow on the Farm

Farmers share below how they monitor cash flow and how cash flow challenges have shaped the way they approach the growth and management of their business. What strategies does each farmer use to manage cash flow?

Melanie Kuegler, Blue Fox Farm (see profile)

We have felt more comfortable buying newer stuff now because our markets have solidified. In the first few years, we weren’t really sure what our year was going to look like in terms of income. Now we have a much more solid picture of that.

When I’m doing the day-to-day bookwork, I’m also looking at our inflow and outflow. I’ve seen that solidify more, so now we feel more comfortable putting a little bit more into infrastructure and new equipment.

Blue fox Farm

Carla Green, Sweet Home Farms (see profile)

We try to butcher almost everything in the fall, freezing it for the rest of the year, so that we have more consistent products and make fewer trips to the processing plant. This is really important, given fuel costs and the labor that goes into transporting.

But this also means a huge amount of money is going out the door for processing that’s not going to come back in for many months. We need to plan so that we have the cash flow we need at that time and have enough to cover expenses after that. Processing is one of our biggest costs.

Sweet Home Farms

Budgeting for Assets, Equity, and Liabilities

In chapter 2, “Do It,” you started to identify the equipment and infrastructure required to get your farm up and running, as well as other assets you will need to acquire over time. You must have access to the capital (money) to purchase these assets when you initially acquire them. For business management purposes, it is important to estimate how much each asset will cost so that you can calculate your total start-up costs (exactly how much money you will need up front). You also must plan for having enough cash on hand (your working capi­tal) to cover your initial operating expenses before any income starts coming in.

After you identify how much your assets cost, you need to address how you plan to pay for them. When you are first starting out and have not yet generated any profits from your business, you need some sources of capital from outside your business. One option is to use your own personal savings to make an equity investment. Another is to borrow money.

When you borrow money to finance the purchase of assets, you are taking on debt and increasing liabilities. You are obligated to repay both the original amount you borrowed (the principal) and the charge for using these funds (interest and fees). Approach this option cautiously and based on realistic financial projections. Lenders look closely at liquidity (your ability to generate sufficient cash to meet financial obligations without interrupting the ongoing farm operation) and the overall financial soundness of the operation.

Especially when you are just starting out, think carefully about where capital funds will come from and the advantages and disadvantages of each source. Below are some of the pros and cons of potential sources of funds for starting your business and for ongoing investments in infrastructure and equipment.

Self-financing. Many farmers start their business with money they have earned through other employment or inherited. Self-financing is a common way to capitalize the farm. In many situations, it may be the only way to develop a business history, which is why detailed record keeping and evidence of improvement in the key business indicators are so important. Self-financing can put personal savings at risk and may compromise family cash flow as the business becomes established.

Family or friends. Borrowing money from family or friends is a viable financing option for many businesses. You may be able to get flexible and attractive terms without needing to put down collateral or fill out complicated application paperwork, like you do for commercial loans. Loan agreements made with family or friends should always be made in writing, with explicit details about the loan terms, including the interest rates, payment schedule, late payment penalties, and default scenarios. Depending on the size of the loan, you should check with a tax professional to make sure the IRS rules are followed. Also keep in mind that borrowing or entering into partnerships with a loved one could strain the relationship if challenges arise with the farm’s or lender’s finances.

Crowdfunding. There are various forms of crowdfunding, but the basic idea is that a large social network helps fund your project. The funds may take the form of donations, payments for rewards, or microloans. Equity investment from individuals in businesses is regulated by federal and state governments, so these platforms generally don’t include the option for funders to own “shares” in the business, but often donations are given some sort of “reward” or interest is earned on loans.

Commercial bank loans. Commercial banks offer various types of credit for small farms. Farm Credit is a nationwide network of borrower-owned lending institutions and specialized service organizations. Local, regional, or national banks may offer farm loans in certain circumstances. Generally, commercial lenders require the following to consider a loan:

1. 1. Three years of financial records that show adequate profits and cash flow
2. 2. Sufficient personal or business collateral (to back the loan in the case of a default)
3. 3. A credit score that indicates that the borrower has a track record of meeting other financial obligations

Commercial banks rarely make loans to start-up farm businesses. Beginning farmers face a high level of scrutiny in securing a loan and must demonstrate a compelling case that the loan makes business sense. Commercial banks have high standards for documenting income and assets, making good accounting records critical.

Government loans. The USDA Farm Service Agency (FSA) offers farm operating and farm ownership loans. These loans are designed for farmers who are unable to obtain private, commercial credit. Both guaranteed loans and direct loans are available through the program. Under the guaranteed loan program, conventional lenders (banks, Farm Credit system institutions, and other lenders) make the loan, and FSA guarantees the loan. Direct loans are made and serviced by FSA officials, who also provide borrowers with supervision and credit counseling. Applicants must show sufficient repayment ability and pledge enough collateral to fully secure the loan. Farmers apply through their local FSA office. As with commercial loans, small farmers who have limited capital and are in their first few years of farming will find it difficult to secure a government loan.

Local economic development agency and Small Business Administration loans. Local economic development agencies are generally structured as nonprofit organizations. Their mission is to help entrepreneurs with low incomes and/or credit issues. Many of these agencies offer loans to businesses that are not able to secure bank financing. Some economic development agencies may also offer other business advising services.

Business funding. Several businesses offer financing at potentially attractive terms. Whole Foods Market’s Local Producer Loan Program provides loans for capital expenditure to small-scale farmers. Their website states that they minimize the fees, interest rates, and paperwork. Equipment companies such as Kubota, John Deere, and Massey Ferguson at times offer zero percent financing for up to 60 months on purchases of qualified equipment. Other equipment and agricultural input companies may offer financing on a variety of terms. As with all financing, farmers should carefully scrutinize the terms of the loan and their ability to repay the debt. Zero percent financing from equipment companies may distort financial realities and encourage purchases that are not justified or wise.

Credit cards. Credit cards may be useful for short-term financing, offering similar advantages and disadvantages to using them for personal expenses. Credit cards offer easy-to-obtain and noncollateralized financing for those with good credit scores, and they often offer attractive introductory terms, like low interest or even zero percent interest for one year. Be cautious about using credit cards for farm financing, since interest rates are generally variable and move higher with time. Most introductory interest offers end after a set period — often one year or less. Farmers who are unable to pay off credit cards before the introductory period ends will be stuck with high-interest debt that is difficult to pay off. In addition, credit limits are often lower than you might need for the business, and a credit card can’t often be used for certain types of expenses (such as labor and used equipment purchased from other farmers).

Government subsidies or grants. Federal agencies offer grant funding for farm improvements, conservation, and on-farm research. Two potential sources are the Sustainable Agriculture Research and Education Program (SARE) and the National Resource Conservation Service (NRCS). Grants generally require extensive paperwork and are useful only for select elements of the farm’s funding needs. The availability of government grants is dependent on their funding and varies from state to state, despite being a federal program.

Individual development accounts. An individual development account (IDA) is a matched savings account that enables limited-income families to save and build assets. IDA participants save a set amount of money; upon the successful completion of the savings terms, they receive a grant of matching funds (often two to four times the amount saved). These programs receive funding from a variety of private and public sources and are frequently administered by nonprofit organizations. These programs are often subject to strict rules regarding the savings period and amount and the types of purchases the funds can be used for. IDA program participants are often required to complete business planning and business education classes, which can offer additional value to the participant.

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The table below shows a sample budget for assets, liabilities, and equity. On the left side are the farm’s assets and the value of each asset. On the right side of the budget are the amounts of equity (self-financing) and borrowed money (liabilities) that were used to acquire these assets. Notice that the total assets are equal to the combined total of equity and liabilities — they are in balance. This budget for assets, liabilities, and equity mirrors the balance sheet, which you will learn about later in this chapter.

Sample Budget for Assets, Liabilities, and Equity

Keep in mind that there is no one right way to finance the costs of starting up your business. It depends largely on your personal or family financial situation and your comfort with taking on debt. It is important that you have a plan for how you will obtain the capital necessary to get started making money. Over time, any profits that you make can be used to pay down debt and/or can be reinvested in the business (used to acquire additional equipment and infrastructure).

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Ultimately, the accuracy of a budget is only as good as the quality of the information used to create it. When first starting out, you must rely primarily on information from outside sources and your best guesses. As the farm matures, you will have your own records to look at and your budgeting will be more informed. There will always be places where you are still guessing, but as your experience grows, you will benefit from your prior work in creating budgets and keeping good records, leading to better guesses in the future.

There will always be places where you are still guessing, but as your experience grows, you will benefit from your prior work in creating budgets and keeping good records, leading to better guesses in the future.

Record Keeping

The first step in the business management process is to clarify your financial goals, and the second step is to plan for how you will reach these goals. The three types of budgets highlighted in the previous section are a key element in that planning process. As you begin to implement your plan, you quickly realize that things do not always go as expected. Keeping good records will help you learn what is actually happening, refine your plans, and continuously improve your farm business.

Accounting Systems

To keep records on the financial aspects of your farm, you must set up an accounting system that tracks income, expenses, profits, cash flows, assets, liabilities, and equity. A useful accounting system has the following characteristics:

1. 1. It is easy to input your data and retrieve that data for the purposes of analyzing your finances.
2. 2. The system helps you maintain the appropriate records for filing your local, state, and federal taxes.
3. 3. Unless you receive immediate payment for everything you sell, the system should allow you to create invoices and keep track of payments so that you can easily tell who has paid you and who still owes you money.
4. 4. If you have employees, you need a system that allows you to run payroll.

Be aware that any accounting system that meets all of the above requirements is going to be somewhat complex and may not feel easy and intuitive the first time you use it. A comprehensive system is going to take some time to learn, so you should make sure to allow both time and funds to pick out and learn a system that matches your needs and helps you grow as a business. The good news is that you do not need to create a system from scratch. There are many good computer-based systems out there today, and even paper-based systems are still in use and can be quite robust.

Hiring an Accountant or Bookkeeper

Professional accountants can help you set up and maintain an accounting system for your farm business — one that allows you to keep good records and easily retrieve that information for later analysis. A good accountant usually has a degree in accounting and understands good accounting practices. A certified public accountant (CPA) is an accountant who is certified by the state to prepare and file your taxes.

Bookkeepers generally have less training than accountants, but a good bookkeeper may be able to perform many of the same tasks when it comes to setting up and maintaining an accounting system. Because bookkeepers usually have less training than accountants, they can be less expensive to hire. A good bookkeeper can also save you money by reducing the amount of time it takes a CPA to prepare your taxes, but the bookkeeper will not be able to prepare your taxes for you.

Many farmers (especially those just starting out) learn to do their own bookkeeping, and some even do their own taxes. Yes, hiring a bookkeeper and/or a CPA is an added expense, but it helps you keep your books accurate and up-to-date. This in turn can ensure that your taxes are filed appropriately, and on time, and that you are paying only the taxes that are required, saving you money in the long run. If you do not like meticulously recording numbers, you might be better off hiring a bookkeeper.

When you hire a professional bookkeeper or accountant, he or she should help you set up your accounting system so that you understand how it works. Be aware that most accountants and bookkeepers are focused primarily on tax issues, whereas you, the business manager, also want to make sure your accounting system tracks the areas of your business you wish to analyze. It is generally best to set up your accounting categories in a way that makes sense when you are analyzing the farm business, then let the accountant sort out what tax category the accounting categories go into at tax time.

Choosing an Accounting System

Setting up a good accounting system from the start will save you a lot of time down the road. By making the information you need more accessible, you will facilitate business planning and analysis. Here are a couple of questions to consider when setting up your accounting system.

Which accounting method should I use — cash or accrual basis? Once you have chosen an accounting method, it is not easy (from a tax perspective) to switch, so consider this decision carefully.

With accrual-basis accounting, income is recorded when it is earned. For example, when a sale is made and the invoice is created, it is considered income — even if the payment has not been received. Likewise, expenses are recorded when they are incurred: that is, as soon as the bill comes due, whether you have actually paid for it or not. Accrual-basis accounting provides a more accurate picture of profitability because it is better at aligning income with the expenses incurred to generate that income. The downside is that it can be more complicated and expensive to implement, and it is often not a feasible option for smaller farms. Certain farm corporations and partnerships should (or are required to) use an accrual method of accounting.

With cash-basis accounting, income is recorded when payments are received and expenses are recorded when payments are made. Although cash accounting is simpler to use and can provide certain advantages in terms of managing tax liability, the cash basis can skew profitability. For example, say you sell a large amount of product in December of this year but you don’t get paid for it until January of next year. If you are on a cash basis, it will look like you brought in less income this year than if you are on accrual basis. If the expenses that are associated with these sales were recorded this year, then your profits for this year will appear lower than they actually are.

One option that allows for using a cash-based accounting system but still provides a more accurate perspective on profitability is to make what are called “accrual adjustments.” Accrual adjustments are basic additions and subtractions made to a cash-based income statement. You can learn more about making accrual adjustments from Converting Cash to Accrual Net Farm Income and Your Farm Income Statement and Preparing Agricultural Financial Statements (see Resources).

What tax rules and options apply to my farm business? Farmers should carefully study the Farmer’s Tax Guide published by the Internal Revenue Service (IRS) (see Resources). This free online publication explains the tax rules for farm businesses and the various options for tracking and recording financial information. One choice that farmers need to make is deciding which method of depreciation for durable property to use. The IRS allows for the General Depreciation Schedule (GDS) and the Alternative Depreciation Schedule (ADS). GDS is popular because it has a shorter recovery period (number of years in the depreciation schedule). This allows for greater deductions on your income tax in the short term. However, for farmers wishing to show a greater net worth (such as in the case of applying for loans), the ADS shows a higher value for the property because the recovery period is longer. (See Farmer’s Tax Guide “Table 7-1: Farm Property Recovery Periods.”) We recommend consulting with a tax professional to establish the best position with regard to your tax bill, while ensuring that you are in compliance with state, local, and federal tax regulations.

Are commercial accounting products worth considering? One of the advantages of using accounting software designed for businesses is that in learning how to use the software, you also learn good accounting practices. It is easy to develop bad accounting habits, so it is often worth reading accompanying manuals or working with a professional to set up the system so that you do not run into problems later.

If you hire an outside bookkeeper or accountant, you will most likely adopt the accounting system (and software) used by that individual. Below are three commercially available accounting systems you might opt to use.

• Manually written ledgers: Paper is still an option, and you can buy books and ledger sheets specifically designed to keep manual records.
• Computer spreadsheets: Common software like Microsoft Excel, Numbers, Google Sheets, and OpenOffice Calc are all excellent tools for budgeting, record keeping, and basic financial analysis.
• Small business accounting software: An ever-growing list of online and desktop versions of software and services like QuickBooks, Sage 50, and GnuCash can organize business records, including invoicing, bills, and payroll, and automate many parts of the bookkeeping.

Most farmers use a combination of all three options, depending on what records they are keeping, what they are analyzing, and if they are using an accountant or bookkeeper. Each has its own place on the small farm.

Keeping Good Records

Accounting systems require good organization and thorough documentation. Make sure to properly back up your records off–site or online in case paper records are destroyed. At a minimum:

• Maintain paper and electronic copies of all sales invoices and payments received. Keep a record of the date the product was ordered, who ordered it, when it was delivered, and when it was paid for (including payment information such as the check number).
• Maintain paper and electronic copies of receipts for all purchases.
• Collect signed sales receipts for all orders. Deliveries to the customer should be veri­fied by obtaining a signed receipt by an authorized recipient. Receipts or invoices for sales should list the payment terms of that sale (for example, payment due upon receipt or due in 30 days). Issue invoices for payment due in a timely manner; many farmers find the best way to issue invoices is at the time the product is delivered in the form of the delivery receipt (the delivery receipt and invoice are the same).
• Keep a cash record. Many farmers collect large amounts of cash from farmers’ market sales; it is important to track what cash is received and where it is deposited.
• Stipulate the terms of sales for restaurant and community-supported agriculture customers. Terms should be clearly stated to customers in writing, including due dates and late charges. Community-supported agriculture businesses should ensure that online or paper signups include details about the membership terms, including refunds, vacations, or missed pickups.
• Document labor. Keep time cards for the farm operator and employees. In many areas, there are different insurance rates for agricultural labor, but on small farms some tasks do not fall into the category of agricultural labor so you may need to track different tasks on time cards separately. You can also use categories on time cards to track different enterprises or tasks on the farm. For example, if you have employees who staff a farm stand and also work in the field, you may decide to track the hours they spend working the farm stand separately on time sheets to help analyze the farm stand enterprise.

Farmers Share Their Experience

Record Keeping: Finances and Inventory Management

We have emphasized the importance of keeping accurate records — for assessing the financial state of the farm, for tax purposes, and for planning the future of the farm business. The farmers quoted here reinforce this message. As you read their comments, note the kinds of data they are tracking and the methods they use to collect, record, and manage that information.

Beth Hoinacki, Goodfoot Farm (see profile)

My bank statements are key, so I maintain a sepa­rate bank account for the farm. It’s the simplest thing in the world to set up: it’s just a second checking account with the farm name on it.

Both my husband and I have debit cards for the farm account, so if we’re buying something for the farm at the feed store, we try to remember to use that card. That way, we can keep track of costs for the farm with our bank statements and our receipts.

Goodfoot Farm

I stuff every single farm receipt into one file in my desk. Now, if I was really good about it, I would divide the file into categories, but at least the receipts get into the folder. When tax time comes, I simply pull out all of those receipts.

I got an accountant because we were doing a lot of capital investment in infrastructure to get the farm going, and she helped with depreciating things. I do payroll taxes myself, but I call her up and run things by her. She answers my questions and gives me advice. She’s a really valuable resource for the farm.

At the farmers’ market, I track my sales in a notebook. It’s kind of laborious and it’s not going to work forever, but it works for me right now because I’m not selling a huge amount of different things.

I write down weights, if it’s a scale item, or the number of bunches and what the produce is. I have another sheet with prices, so I can look back and calculate how many pounds of potatoes or bunches of kale I sold at a particular market.

At the end of the year, if I have the time and inclination, theoretically, I could sit down with these notes and calculate exactly how many pounds of potatoes, bunches of kale, or pounds of apples I sold — that sort of a thing. And hopefully, that could link back to some production costs.

Randy Kiyokawa, Kiyokawa Family Orchards (see profile)

I use an accountant for year-end record keeping, and I have a bookkeeper who comes in once a month. I like to pay my own bills, and I like to do my own payroll. That way, I keep a pulse on everything that’s going on.

I use QuickBooks. We’ve tailored it to fit our operation, and the fact that we pay both hourly and sometimes contract. I feel like I can make my best decisions if I know what’s really going on financially with the operation.

When I do the inventory for a farmers’ market, such as how many boxes we’re going to send out, I put those numbers on a spreadsheet so that I can track them and can copy and paste to the next week. I do the same thing with the inventory for the restaurants and stores that we deal with.

Kiyokawa Family Orchards

Carla Green and Mike Polen, Sweet Home Farms (see profile)

Carla: We used QuickBooks for our finances. The program requires some understanding of accounting, which we were sorely lacking in the start. It took a while to figure out how to use the program.

We had accountants prepare our taxes. We had our property’s LLC [limited liability company] and also the farm LLC, so our taxes were pretty complicated and, unfortunately, expensive to get done. But it was just beyond our capacity.

Fortunately, as we got better with QuickBooks, we provided better records to the accountant. We also had a bookkeeper who did our payroll for us, which was very helpful.

We are trying to come up with a record-keeping system for our inventory management. We don’t have a way to track the sale of each cut of meat. We are trying to figure out a way to do this.

Sweet Home Farms

Mike: We struggled with being able to reliably predict the yields of salable meat from, say, an annual crop of calves or an annual crop of lambs. In other words, if we started with x number of lambs, what is the average hanging weight for those animals and the average meat yield from those weights?

Our yield estimates improved, but we would have liked to be able to estimate how many cuts of various kinds we would have available to sell so that we could have a truer estimate of our income over the next three to six months.

We did a pretty good job, I think, of keeping records for different aspects of the enterprise, but we struggled with finding the time to analyze them and effectively use that information.

Financial Statements

A key function of your accounting system is to keep records of what actually happens with farm finances. Financial records are typically organized into reports called financial statements. There are three financial statements commonly used by most businesses: a profit and loss statement, a cash flow statement, and a balance sheet. These statements are closely related to the budgets that we looked at earlier. The difference between a budget and a statement is that a budget is a projection or plan for what you think will happen in the future, and a statement is a record of what actually happened.

Profit and Loss Statements

The profit and loss statement (P&L) shows income that was earned, expenses that were incurred to earn this income, and the profit that remains. The P&L measures a business’s net profit over a specific accounting period, such as one month, one quarter, or one year, with one year being the most common period used. The P&L is also known as the “income statement” or “statement of revenue and expenses.” The purpose of the P&L is to show whether the business made or lost money during the period being reported. The profit and loss statement mirrors the budget for income, expenses, and profit we looked at earlier. The two can be used together to assess differences between what was projected and what actually occurred.

Cash Flow Statements

Cash flow statements show where cash came from and how cash was used; it explains changes in cash assets from one period to another. The cash flow statement demonstrates a business’s ability to cover current expenses, pay debts, and invest in new equipment and infrastructure by highlighting cash surpluses and cash shortages. The cash flow statement is directly related to the cash flow budget that we looked at earlier. Both show cash inflows and outflows over a period of time. Cash flow budgets project what future cash flows are expected to be; cash flow statements document actual cash flows. A cash flow statement differs from a profit and loss statement in that it focuses only on changes in cash and does not indicate the profitability of the business, since some cash inflows are not income and some outflows are not expenses.

Cash flow statements typically categorize cash based on the business function it was used for: operating activities, investing activities, or financing activities. Cash used for operating activities includes cash inflows and outflows related to the core functions of a business. For farmers, core functions are producing and selling products from the farm. Cash inflows and outflows related to purchases or sales of equipment and infrastructure are categorized as investing activities. Financing activities are related to cash inflows and outflows from loans, credit lines, mortgages, and owner’s draws.

Balance Sheets

The balance sheet is also known as a “statement of financial position.” This statement is a snapshot in time that shows the value of the business’s assets and the liabilities and equity that support these assets. More simply, the balance sheet shows how much the business owns and how much the business owes at a moment in time. The value of the farm’s assets is always equal to (and “in balance” with) the combined values of the farm’s liabilities and owner’s equity. Earlier in this chapter, when you budgeted for the assets that you need to purchase and then planned for how to finance these assets, you essentially created a projected balance sheet. Over time, as profits are generated and reinvested in the business — either by buying additional equipment and infrastructure or simply by keeping more cash on hand — the owner’s equity also increases and the farm’s financial position improves. These changes are reflected in changes in the balance sheet from one period to the next.

. . .

The financial statements described here are typically requested by lenders, business partners, or investors when they want to make an assessment of your business. They are also useful (in combination with the budgets you have developed) for doing your own assessment and analysis of how well your farm business is meeting your financial goals.

Analysis

The final step in the business management cycle is to use your budgets and records together to analyze your farm business. This will give you a clearer understanding of your farm’s financial situation, so that you can make informed decisions about how to revise plans and budgets going forward.

Variances

One of the simplest methods for analyzing your farm business is to look at variances. A variance is the difference between a projected budget amount and the amount reported in your financial statements (what actually happened over the course of the season). If you have a good accounting system in place, you should be able to quickly generate financial statements, and the categories in those statements should match the categories in your budgets in a way that allows you to easily calculate the variances.

To analyze variances, first look at what may have caused the difference. After you have identified the cause, you can evaluate the impact of the variances and how to address any problems. For variances that have a negative impact on profits (such as a shortfall in sales or overspending on labor), you need to come up with solutions for fixing the problems before they become catastrophic. If the variances are in your favor (such as better-than-expected yields and sales or lower-than-expected spending on supplies), you should still do a quick check to make sure the source of those variances is not going to cause problems in the future. Examples that might cause future headaches include future shortfalls in product to sell or problems with long-term fertility in the fields. As long as there are no potential problems, you can pat yourself on the back for a job well done in creating a conservative budget and exceeding expectations.

Analyzing the Profit and Loss Statement

Variances are particularly useful in analyzing the difference between projected and actual income, expenses, and profit. The primary benefit here is to make future budgets more accurate.

The table below shows a comparison between a budget for income, expenses, and profit and the actual income, expenses, and profit from a profit and loss statement. What variances do you notice in this table?

Sample Profit and Loss Statement Showing Variances between Budgeted Amounts and Actual Amounts

Example of variance from a budget to the actual amounts on the Profit and Loss statement. (U) indicates unfavorable; (F) indicates favorable.

When evaluating variances, a good starting point is to look at the difference between the amount of projected profit and the actual profit that was earned. If the difference is favorable (actual profits were more than projected profits), you will probably be pleased. An unfavorable difference (actual profits were less than projected profits) will be cause for concern. Both scenarios warrant further investigation to see how well you budgeted for each income and expense line, and to learn from the variances. Here are some questions you might ask yourself if you did not reach your profit goal:

• Are actual sales less than the sales that were budgeted/planned? If so, why?
• Were yields less than expected?
• Was selling the planned amount of product a challenge?
• Did prices need to be adjusted?
• Were there other challenges in the marketplace?
• Are actual costs more than the costs that were budgeted/planned? If so, which costs were over budget and why?
• Was the cost of labor higher than planned, or did you use more labor than budgeted for?
• Did other inputs (fertilizers, seed, feed, fuel, and so on) cost more than you budgeted or did you use more than you planned?

Improving Profitability

If you are not meeting your profit goals, you should consider what operational changes can be made to improve profitability. And even if you are profitable, you may want to look at ways to become more profitable.

Increasing sales. Assuming you sell your product for more than it costs to produce, increasing sales will improve your profitability. This may mean doing more market research, including conversations with your customers where possible, to make sure there is a market for what you are producing. Soliciting customer feedback is essential — both before and during the season. If there is a quality issue (or some other issue with your product), it is far better that you find out about it and have the chance to correct it before you lose sales or customers.

Increasing yield. If yields are lower than planned, this will impact both the income you bring in (reducing potential sales) and your costs of production (since preharvest production costs will have to be spread over more units). Strategies for increasing yields include choosing crop varieties and animal breeds that are suited for your location and identifying optimal planting dates and feeding schedules. To increase yields, you may need to increase some of your spending on inputs, such as fertilizer and water. Weed pressure can have a big impact on yield; investing in labor to control weeds often pays off with increased yields and reduced harvest and cleaning time.

Reducing expenses. When it comes to reducing expenses, your financial statements can steer you toward the expense categories that have the biggest impact on total costs. It may help to list all your expenses and calculate what percentage each category contributes to the total. The Expenses as Percentage of Total Expenses table below provides an example. Looking at expenses this way can focus your efforts on the expense category that will have the greatest impact. In the example, note that the payroll expense makes up almost 72 percent of total expenses. This area may have the most room for improving the bottom line (profits).

Expenses as Percentage of Total Expenses
Expense Category	Expense Amount	Percentage of Total Expense
Payroll	$48,000	71.9%
Soil amendments	$4,200	6.3%
Seed	$2,800	4.2%
Greenhouse supplies	$1,500	2.2%
Fuel (on and off farm)	$100	0.1%
Utilities	$1,450	2.2%
Repair and maintenance	$800	1.2%
Equipment rental	$250	0.4%
Packaging	$200	0.3%
Market fees	$300	0.4%
Insurance	$1,000	1.5%
Land rent	$2,200	3.3%
Depreciation expense	$4,000	6.0%
TOTAL EXPENSES	$66,800	100.0%

Strategies for reducing labor costs fall into three general categories:

1. 1.Timing. Focus on getting things done on the farm at the right time. Weeding can take twice as long (or more!) once weeds have gotten away from you — not to mention that weeds that go to seed will cost you more in labor in future seasons.
2. 2.Training. Focus on training your employees (and yourself) to work efficiently and ergonomically.
3. 3.Technology. Focus on using appropriate technology to reduce labor costs. This does not mean you need to mechanize everything on the farm, but certain investments in equipment and machinery may be worthwhile in terms of the labor expenses they will save you.

In addition to the strategies above, you may want to consider outsourcing functions that you, or someone on your farm team, are not skilled at or do not have the capacity to handle. A new farmer may find it makes more financial sense to hire skilled services for certain tasks. It’s better to hire someone on contract when needed than to struggle and waste valuable time trying to get the job done. Tasks that are done incorrectly can produce results that hurt the business, ultimately costing more money.

Another strategy for reducing costs is to buy production inputs in bulk quantities. If you have a good place to store seeds or feed, it can pay off to buy a full season’s worth rather than small quantities here and there. Consider pooling orders for supplies with other farmers in order to buy in larger quantities and benefit from bulk discounts.

Finally, consider if it makes more sense to rent equipment rather than purchase it. Note in the sample profit and loss statement that there is a depreciation expense of $4,000. Suppose this includes the annual ownership cost of a $25,000 tractor distributed over 10 years. If a farm is utilizing the tractor close to capacity (it’s not spending most of its time sitting in the barn), this purchase makes sense. A smaller farm that is just getting started might not be at a large enough scale of production to afford this expense. In these circumstances, it makes more sense to rent. While renting does involve some trade-offs, it allows you to only pay for the capacity that you need, when you need it.

In general, it is important to take a balanced approach to spending. Overspending reduces profitability and means more cash outflows, but underspending can also cause problems. Many spending categories are absolutely neces­sary and are at their core investments, meaning their cost will be offset directly by future resulting income. This is commonly called “return on investment,” or ROI. A farmer who skimps on needed fertility inputs or labor to control weeds could be reducing yields and potential sales to a far greater degree than the money saved. The old adage “You must spend money to make money” is often true when investing in needed farm labor, inputs, supplies, equipment, and infrastructure.

Farmers Share Their Experience

Farm Financing: Perspective on Growth and Capital Investments

We often raise the question of how much risk you are willing to take on in managing your farm business. After going through this chapter, you may have new perspectives or insights into financial risk and what financing options you are most comfortable with. Below you will learn how several farmers have worked through this issue of financing, from start-up to growing the business. How would you compare each farmer’s tolerance for risk?

Sarahlee Lawrence, Rainshadow Organics (see profile)

In terms of building the farm and my infrastructure, I wanted to start out with a minimum amount of input because I wasn’t sure if I was going to like farming.

Rainshadow organics

Melanie Kuegler and Chris Jagger, Blue Fox Farm (see profile)

Melanie: We’ve taken the approach of not going too far into debt at one time. At the end of each year, we’ve sat down and looked at our profit for that year, which has helped us determine how much we can put into infrastructure for the coming year.

Chris: We’ve always been a pay-as-you-go kind of farm just because we didn’t want to get in over our heads. If we wake up one morning and realize we just can’t keep doing this, we don’t want to have a ton of debt hanging over our heads and go under. It’s not that we feel that would happen; that’s just how we’ve worked.

Paying as we go has been really good for us, too, because it has prevented us from growing our operation too quickly. We really have to incrementally increase our scale.

Our home property where we started as well as our other piece of property are owned by a family trust. We’ve put that into an LLC, which oversees just the pieces of land. If we didn’t have Melanie’s parents behind us in that way, I don’t think we could have done it from the start. But at the same time, we have to work hard to make the mortgages on both properties.

Blue Fox Farm

Enterprise Analysis

A profit and loss statement is a great place to begin looking for the costs that might need attention. Eventually though, you will want to look at how much each individual enterprise on your farm contributes to (or detracts from) your bottom line. To do this, you must break the farm into separate enterprises. You can think of enterprises as income-generating centers within your business — usually specific products, market channels, or other areas of the farm, like a greenhouse that supplies seedlings for field production or a breeding program that supplies piglets. Looking at the income or cost reduction generated by a single enterprise on the farm and comparing that to the costs that are specific to that enterprise can give you key insights into how you might improve the profitability of your farm and whether or not certain products are worth producing.

Calculating the production costs for individual products can also identify the prices you need to charge to cover your costs. In general, some level of competition-based pricing is unavoidable in our market-based economy, but knowing your costs can help you make the argument to your customers that you need a higher price.

Calculating specific costs of production is beyond the scope of this book. Most farmers typically need a few seasons to get their systems established before they are ready to focus on the record keeping required to determine their own costs for specific enterprises. When you are ready, refer to the Resources section for a list of suggested tools and training materials that can help you with the costing process. In the meantime, enterprise budgets developed by land-grant universities can help you estimate the costs for individual enterprises. Several cost-study and enterprise budget websites are listed in the Resources section, or search the Web for “crop enterprise budgets” or “farm enterprise budgets” with your state’s name.

Profit Benchmarking

We define profit as the difference between your income and your expenses. In the income and expenses budgeting section of this chapter, we refer to profit as “net income.” Unfortunately, it is not quite as simple as it looks. Not everyone includes the same categories in income and expenses when calculating profit. This is especially true when it comes to including the cost of paying yourself, the farmer, for the time you put into your farm business. If you are a sole proprietor, technically any money you take out of the business for personal use (commonly called an owner’s draw) is not an expense. To analyze profitability, you might want to track this differently, so that your labor is counted as an expense. On the other hand, businesses that are incorporated (see the section on Business Structures in chapter 6, “Keep It”) are required to pay anyone, including the owners, as employees. In that case, even owner labor would be considered an expense and the profits would look very different, even if the farms were otherwise exactly the same.

Profit calculations are often made pretax, but not always. To get a realistic idea of how much money you will actually have at any point during the year, it’s a good idea to include estimated tax payments in your budget.

One way to gauge how you are doing is to compare your profits (and other metrics) to other farmers’ numbers, but you need to be careful when doing this. You must understand what other farmers are including and what they are leaving out. Another good option is to compare profits and other metrics in your own farm business from one year to another.

Analyzing Cash Flow Statements

The main purpose of a cash flow budget is to reveal future cash shortages so that you can plan ahead and come up with strategies to avoid them. Cash flow statements tell you when things are going as planned and when they are not (which is most often the case). For this reason, it is important to monitor and analyze cash flow regularly (at least monthly) so that issues can be addressed in real time. (This is different from either the P&L or the balance sheet, which are analyzed at the end of a full production cycle — typically a growing season.)

The table below shows a simplified cash flow statement. In this example, the farm started with $10,000 in cash. Significant cash outflows (from expenses) occurred in January, and February and March had no cash inflows (from sales). In the first three months of the year, more cash went out than came in — meaning the farm’s cash flow was negative. By June, this trend reversed and cash inflows (from income) started to outweigh cash outflows — meaning cash flow was positive. This trend continued for the rest of the year. This cash flow statement shows no months with a shortfall, so the farm does not need to consider any strategies to avoid cash shortages in the future. But what if it did? What if it was late spring, and cash started coming in later and more slowly than expected?

Sample Cash Flow Statement
Month	Starting Cash	Cash In	Cash Out	Ending Cash
January	$10,000	$0	$1,000	$9,000
February	$9,000	$0	$2,000	$7,000
March	$7,000	$0	$3,000	$4,000
April	$4,000	$1,000	$3,000	$2,000
May	$2,000	$2,000	$3,000	$1,000
June	$1,000	$4,000	$3,000	$2,000
July	$2,000	$6,000	$3,000	$5,000
August	$5,000	$8,000	$4,000	$9,000
September	$9,000	$9,000	$4,000	$14,000
October	$14,000	$6,000	$2,000	$18,000
November	$18,000	$6,000	$1,000	$23,000
December	$23,000	$3,000	$1,000	$25,000

Strategies to Improve Cash Flow

Borrowing. Tight cash flow requires some farm businesses to utilize loans or short-term credit. This is especially true for more immediate cash flow issues when you can’t employ other, longer-term strategies. It takes time to apply for and secure a loan or a line of credit. A loan will give a one-time lump sum, while a line of credit will give you less money over time but will give you more flexibility about how the funds are used and paid back. The borrower can draw down on the line of credit at any time, as long as he or she does not exceed the maximum set in the agreement. The advantage of a line of credit over a regular loan is that the borrower doesn’t usually have to pay interest on the credit that is unused, and the borrower can draw on the credit as needed. Some credit terms require that the outstanding balance be paid immediately at the financial institution’s request. Credit cards are lines of credit, but sometimes banks or credit unions offer better rates to businesses than major credit cards do.

Advanced payment arrangements. Sales arrangements where farmers charge customers in advance can help cash flow. Community-supported agriculture is one such approach (described in more detail in chapter 3, “Sell It”). Certain arrangements for direct marketed meat products may also require customers to pay in advance. Advanced payment arrangements may have higher administrative costs and/or a limited customer pool. This is a long-term strategy, since it takes time to develop these types of sales arrangements. Note that taking payments in advance obligates you to deliver in the future, so be clear with your customers about the risks in the case of a crop failure or lower-than-expected yields.

Terms on receivables. Take steps to get paid quickly by setting strict and short-duration payment terms on restaurant and wholesale accounts. Some small farms request that restaurants pay upon delivery. It may be more challenging to negotiate payment terms with large-scale sales outlets because these businesses are more likely to dictate their own terms. Each farm business must evaluate how strictly they want to enforce payment terms, and if they want to impose penalties such as late fees, interest, or dropping delinquent accounts. Accepting electronic payment by bank wire or credit card may in some instances improve cash flow, but it can also result in additional fees. Establishing or changing terms on receivables might take less time than developing new payment arrangements, but it is still a long-term strategy for addressing cash flow issues. In some wholesale markets, it is not uncommon for farmers to wait months to be paid for invoices.

Analyzing Balance Sheets

The statement of financial position, otherwise known as the balance sheet, is less useful as an internal management tool than the profit and loss statement and the cash flow statement. However, it does show how net worth (owner’s equity) changes from the beginning of one period to the next.

The sample balance sheets opposite show two simplified balance sheets, one from the beginning of the year and one from the end. Notice that both assets and owner’s equity have increased by $10,000 from the beginning of the year to the end. This increase is a result of profits that have been retained in the business.

When you are just starting out, it may feel like there is little financial reward for all your hard work. But remember that investments in equipment and infrastructure are actually increasing your owner equity from year to year. Farmers in this situation should look at their balance sheet periodically to get a true picture of their financial position. They may be doing much better than the profit and loss statement indicates.

Sample Balance Sheets
	Beginning of Year	End of Year
Assets	$60,000	$70,000
Owner’s equity	$40,000	$50,000
Liabilities	$20,000	$20,000
TOTAL ASSETS	$60,000	$70,000
TOTAL EQUITY + LIABILITIES	$60,000	$70,000

Financial Ratios

Financial professionals use a number of ratios to assess the financial health of your business to determine if they will lend to you. Each ratio looks at a slightly different aspect of the financial picture, so you need to calculate and interpret them very carefully. The actual numbers in a ratio can give you some indication of a farm’s financial situation, but more commonly, ratios are evaluated against certain benchmarks that indicate the financial health of the business. These benchmarks vary according to the type of business you are running and the stage of the business’s growth. Some financial ratios are used in relation to each other, and that relationship is more important than the absolute numbers. Tracking and comparing the ratios over time can give you an indication of how your business is improving or where problems might be developing.

The current ratio, the ratio of current assets to current liabilities, is one financial ratio that lenders use. In this case, “current” means short term — generally less than one year. Obviously, you want your current assets to be higher than your current liabilities; otherwise, you cannot pay your bills and are in imminent danger of failing as a business. General financial guidelines might say that a ratio of 1.5 or better is good, and if you are between 1.0 and 1.5 you are okay, but under 1.0 signals trouble.

When calculating and analyzing any financial ratio, be consistent and compare it to numbers that are calculated in the same way. For example, with the current ratio, are you consistent in how you identify what is “current” and what is longer term? Did you just purchase a piece of equipment that is making your current assets look lower or your current liabilities look higher than usual?

If you are interested in looking at more ratios and you have a good accounting system, it should be relatively easy to pull out the numbers that you need to calculate them, but make sure you understand clearly how the parts of the ratios are defined and what the ratios are indicating before trying to use them. The book Fearless Farm Finances from MOSES (Midwest Organic & Sustainable Education Service) has a detailed section on ratios for farmers that will get you started.

Farm Plan

Worksheets for Business Management

With a better understanding of business management practices for your farm business, this is a good opportunity to review several of the farm plan worksheets you have worked on in previous chapters. In particular, take a look at the Values and Vision (appendix 1-5) and Ideal Farm (appendix 1-4) worksheets from chapter 1, “Dream It.” In addition, we provide five farm plan worksheets specifically related to what we have covered in this chapter (appendices 1-19 through 1-23).

Budgets and Variances

The Budgets and Variances worksheet (appendix 1-19) will help you prepare a whole farm budget for your business. Remember to clearly define the parameters and goals of your budget (such as type of farm, product, acreage, start-up, seasonal, and expansion). If you are in the very beginning stages and are not yet operating a farm business, create a hypothetical budget based on your current plans and projections. Remember, you don’t have to complete this in one sitting. Do what you can, then return to it later as you have more information.

Cash Flow and Accounting Systems

The Cash Flow and Accounting Systems worksheet (appendix 1-20) gives you the opportunity to evaluate your cash flow situation and also describe the accounting system that you have set up or that you think will work best for your farm.

Production Costs

The Production Costs worksheet (appendix 1-21) will help you assess how well you are managing costs for your farm business. If you cannot complete the table at this time, that’s okay. Do what you can, then return to it later as you work through the remainder of the chapters.

Financing

The Financing worksheet (appendix 1-22) is designed to assess current and future financing options. If you are farming now, indicate if you currently use a source of financing, how much debt you currently hold in each financing category, and when you hope to pay off that debt. Also indicate if you want to pursue that source of financing in the future. If you are not yet farming, indicate if you want to pursue that source of financing and provide an estimate for how much financing you will be seeking.

Balance Sheets

The Balance Sheets worksheet (appendix 1-23) will help you create a balance sheet for your farm business. If you are already farming, use current figures for your farm. If you are not yet farming, try developing a hypothetical balance sheet using the best data you have.

It’s Not All about Dollars

When analyzing the financial situation for your farm, remember that dollars are only one measure of success. While it is important to make a profit (or at least break even), it is also important to consider quality-of-life issues for yourself and your farm team and to consider the health and sustainability of your community and the natural environment where you live and work. These considerations may not have dollar numbers attached to them, but they are important for the long-term sustainability of your farm business and should be factored into your decision-making.

Manage ItPutting It All Together

Many farm businesses are successful over the long term and, in time, pass from one generation to the next. What is the secret to their success? There is no one answer to that question, and even businesses that have been successful in the past may find themselves struggling as circumstances change. Nonetheless, farmer experience points to several management tips that can help keep you moving in the right direction.

Business Management Tips from Successful Farmers

• Be cautious about borrowing, but do not undercapitalize the business. Many businesses fail because they are undercapitalized.
• Expect frequent challenges in the early years of the business, with steep learning curves and high start-up costs.
• Always overestimate expenses and underestimate income to account for unforeseen challenges like equipment breakdowns, effects of bad weather on crop yields, or weak markets.
• Do not overspend on materials, supplies, and equipment the farm does not really need.
• Understand that direct marketing strategies require time and resources, thereby affecting your overall costs.
• Be cautious of early-season cash flow issues.
• Establish reasonable ways to pay yourself for your work.
• Emphasize the production of the most profitable crops; know which ones they are.

Blue Fox Farm

Adapting to Change

Blue Fox Farm is a 67-acre diversified vegetable farm in the Applegate Valley of southern Oregon. Melanie Kuegler and Chris Jagger have been farming there since 2003.

Chris and Melanie did not have any exposure to farming while they were growing up. They were town kids. Chris went to college at Iowa State University. “I started getting curious about where my food was coming from and started tracing it back until I got to production. And then when I got to production, I was really intrigued by that whole side of it and feeding people.” Melanie says she grew up the first 18 years of her life barely knowing what a farm was. “I went to college in Santa Cruz, UCSC, and started doing some work at the farm on the campus and doing some internships at smaller farms around the Santa Cruz area. And that’s where I fell in love with it.”

Melanie and Chris started out as farm managers in California and Colorado, then they began looking for their own farm in 2002. They were attracted by the beauty of southern Oregon and did their homework to research the business potential in that part of the state. “When we found this piece of property, we just went for it. We had just enough money to put a down payment on the land and one tractor. We started with an acre and a small booth at two farmers’ markets,” says Melanie.

“The second year we farmed about two acres,” says Chris. “It was one of those grueling years, but it was good that we went through it to get a true visual imagery of what the whole system involved. So we’re fortunate to have been able to start from the ground up.” From the initial production on their home property, Melanie and Chris expanded on a mix of purchased and leased land until they had 35 acres in production. After farming at that level for several years, they have now scaled back to producing on about 15 acres each season.

They sell their produce through a variety of market channels including farmers’ markets, wholesale to grocery stores, and direct to restaurants. They also operate what they call a Market Bucks program where community members invest in the farm at the beginning of the season and, in return, get credits that they can use to buy produce at the Blue Fox farmers’ market stand at a reduced price. They also sell to a wholesale distributor (Organically Grown Company) out of Eugene, Oregon.

“Our vision has changed because we’ve grown and changed,” notes Melanie. “We’ve started a family, which means I am at home with the two children a lot and we have to hire other people to help. I can’t be out there working the hours that I was working before. And I think things have changed because we’re responding to what the markets want, so what we’re growing and how much we’re growing has definitely evolved over the years.”

Melanie and Chris attribute much of their success as business owners and managers to their adaptability. “Part of our discussion in our down period each year in December is, How do we look at the next year? What has changed? And how do we adapt to it? And we’ve seen a lot of success so far, year to year, I feel, primarily because of that,” says Chris.

“We want people to get good-quality fresh produce. And we want to do that while being able to afford what we need for our family in terms of good food, good clothing, good housing, health care, et cetera. And we want that for our employees. So our highest value is making sure that we’re all taken care of while producing good product for people,” says Melanie.