Important concept of financial management skills

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It’s a time of year when many farms focus on the financial aspects of their business.

The purpose can be broad, ranging from retrieving financial statements from accountants to preparing information to file tax returns and providing information to lenders. For many farms, focusing on financial management is not something they look forward to.

However, many farms are genuinely interested in finding ways to better understand their farm’s financial performance and associated strengths and weaknesses. I’m going to share with you some of my thoughts on money management skills.

Improving financial management skills can be seen as a step-by-step approach to development. Do this, then do that, for example, but always working towards greater understanding.

Image 1 depicts a common on-farm financial management structure, where an accountant (internal or external) records transactions in accounting software and submits a year-end file to an accountant. The accountant then provides financial statements used by both the farm management team and the lending institutions.

Frame 2 would be the preferred process flow. Financial information is first captured at the accounting function level and then used as needed to support budgeting, actual-to-budget analysis throughout the year, and for reporting to lenders and owners/ management team.

Two questions are fundamental to a better understanding of financial performance:

  • How do you use available financial information in the best interests of your farm?
  • What should your financial performance look like in the future (a time to be determined) to ensure owners and stakeholders are able to make the required investment decisions?

In other words, what are you doing financially?

Key to the above questions is alignment within your financial management processes. This is important and refers to financial information entered at the administrative (accounting) level and used by:

  • Accountants for compliance requirements (reporting and taxation).
  • Lenders for borrowing and performance review requirements.
  • Owners and managers.

They are used for:

  • Performance analysis review; focused on history and the future.
  • Investment and financing decisions.
  • Operational decisions.

If there are gaps in alignment, meaning different financial information is used for different purposes by different people, important understanding may be lost in translation. The risk is that decisions are then not based on good and solid information.

To apply this concept on the farm, review and adjust your existing chart of accounts to enable efficiency and accuracy in the alignment of accounting functions and related financial management processes, as outlined above.

Create processes that you can use to enable quarterly financial reporting (could be monthly in the future if needed) year-to-date and apply budget analysis to actual.

The goal is to be able to review your financial performance throughout the year. The aim is to take mid-year performance and, through review and analysis, adjust where possible to create the best possible year-end numbers. Obviously, once your year is over, mid-year adjustments are no longer possible and the results for the year are the results.

Quarterly reports should include balance sheets and income statements, so maintaining accurate accounts payable, receivable and especially inventory is essential.

Set financial goals and investment guidelines for your farm. This information is used to “test” actual financial performance against some point in the future. It helps you determine if you are making progress or if adjustments may be needed.

The one-year income statement, balance sheet and cash flow projections must be prepared. These are the budgets against which you will compare progress throughout the year.

The budget-actual analysis referenced above uses the budget information entered in the projections.

A rolling five-year capital budget should be developed.

Review the most recent year’s financial performance by calculating key ratios. Ideally, five years of ratios should be used so that trarticle_paragraphs can be analyzed.

The process outlined above provides information you can use to better understand your farm’s financial strengths and weaknesses.

I understand that there will be other approaches you might consider to advance your farm’s financial management skills.

The method described above is the framework I use when working with farming families who want to hone their financial management skills.

Terry Betker, PAg, is a Winnipeg-based farm management consultant. He can be reached at 204-782-8200 or [email protected]com.

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