Farm Finances Glossary
Accounts payable/receivable event occurs, rather than when the cash amortization period will lead to smaller changes hands. The accrual method is monthly payments but a larger total Accounts payable is a liability account on preferred if you want your income payment. the balance sheet. It includes all invoice statement to best reflect your current payments due to your vendors for financial situation. In the feed example, a Appraisal products/services already received. farm practicing accrual accounting would record a feed expense as their livestock A formal valuation, usually of a piece of Accounts receivable is an asset account eat it, not when they buy a pallet-load of property prior to purchase. A lender on the balance sheet. It includes all cash feed. Accrual method adherents prefer usually orders a property appraisal due to your business by its customers for that their financial statements reflect before formally offering you a loan, to products/services already provided. economic activity, instead of cash ensure the property is truly worth what
changing hands. you (and therefore they) are paying for it. Accrual accounting The accrual method is more complicated You will run into problems buying Sometimes the exchange of cash does than cash accounting. It requires property if the property’s appraised value not time up with an economic event that maintaining accounts payable, accounts is less than its purchase price. Lenders needs to be accounted for. Some receivable, and prepaid expenses secure your loan by issuing a lien against examples: Do you account for the accounts to track transactions that are the property in case of default, so they purchase of livestock feed when you buy recorded without an exchange of cash, will not offer a loan if seizing your a pallet of bulk feed, or as your animals and exchanges of cash that have not property would not recover their full consume it? Do you record a sale when been recorded. investment. In these cases, a large down you deliver your products, or when you payment or additional collateral will be receive payment from your customer? Amortization required to get a loan.
There is no right way to account for these Farmers will most often hear Assets events, as long as you do it consistently. amortization used to describe the span of There are two methods of accounting: time over which a loan is to be repaid. A Assets are a type of account included in cash or accrual. In an accrual accounting thirty-year mortgage, for instance, is the balance sheet. There are many asset system, transactions are considered to amortized over 30 years. For a given loan accounts, such as cash, land, equipment, have happened when the economic amount and interest rate, a longer and accounts receivable. Asset accounts
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can include an individual item – a that with the income statement and gain is taxed at lower rates than ordinary potential example is land, if you own one statement of cash flows, which document income – possibly not at all, for people in property – or many items – supplies, for a span of time, usually a year. lower tax brackets. instance, may include all of your Lenders rely on your balance sheet to greenhouse and office supplies. Business plan determine your creditworthiness. On the balance sheet, asset accounts Analyzing your balance sheet alone A business plan is a document that should be listed at their book value. The allows them to understand your current communicates the future goals of an asset account for your farm, if you own it, indebtedness and what kind of collateral enterprise and how they will be achieved. should be listed at the price you paid for you own. When your balance sheet is Usually created for a loan application, a it; any appreciation to the property value analyzed along with an income business plan is a useful tool for anyone is not realized unless you sell it. It is OK, statement, lenders can calculate financial starting or changing an enterprise, even common, for market value and ratios to understand your business’s especially when management is shared book value of an asset to differ. ability to pay back a loan. Often lenders with a team. Overall, a business plan is a will require you to share a personal If you have a loan for a particular asset, stated goal, or series of goals, for the balance sheet in addition to your you would still list the full cost of that business, supported by pro forma business balance sheet. asset in its asset account. You will have a financial statements, and an explanation
separate liability account for the loan of how the goal(s) will be accomplished. Book value associated with that asset, which will Business plans should contain the decrease as you pay back the loan. The value of an asset on your balance following information: There are both long-term and short-term sheet (“on the books”); usually the • Overview/description of the company (or current) asset accounts. (See current purchase price minus any accumulated and its owners assets.) depreciation. Book value does not • Stated goals of the company always, or even usually, match the • Value proposition Balance sheet market value of an asset. • Market analysis • Risk analysis If you sell an asset with a higher market The balance sheet is a summary of your • Capital plan value than book value, such as farmland farm’s assets, liabilities, and owner’s • Current financial position and that has increased in value over time, you equity at a given point in time. Contrast historical financial statements will “realize” a capital gain. This type of
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• Projected financial information income or (potentially) taxed unless the booked to your 2018 revenue if you asset is actually sold. practice cash accounting. There is no standard format or required length for a business plan. It can be one Capital gains are subject to lower tax Small businesses without dedicated page for a simple operation, or one rates than other income, or for those in accounting staff are more likely to hundred for a complicated enterprise. lower tax brackets, not at all. practice cash accounting. It is easier to Ask your loan officer if they have a manage and, arguably, easier to business plan format that they prefer. An Capital plan understand. internet search will yield many templates. A capital plan should be included in a Cash flows Capital expenses business plan, especially if that business plan is part of a loan application. The Cash flows are the dollars coming into Certain assets which give a long-term capital plan schedules the capital and going out of your business. The benefit to the farm, such as equipment expenses you intend to make. It can be as statement of cash flows is one of three and buildings, can be depreciated over simple as a list of items along with their main financial statements. When created the “useful life” of the asset. Purchasing prices and the year in which you plan to as a historical financial statement, the these assets is considered a capital purchase them. statement of cash flows shows how expense, in contrast to an operating business activity over a certain period expenses, which offer a shorter-term Cash accounting affected your company’s cash reserves. benefit and are therefore written off Every business plan should include a pro- immediately. For context on accounting methods, see forma statement of cash flows, which is a our entry for accrual accounting. Note that land is not considered a capital future projection of how cash will enter expense, and is not a depreciable asset. When accounting on a cash basis, and exit your business. For farm transactions are reported whenever a businesses, it is helpful to look at Capital gain (loss) cash transaction is made, no matter monthly, rather than annual, cash flows when the actual economic activity because farm expenses and incomes vary A capital gain occurs when an asset’s occurs. For example, if you deliver to a with the seasons. A pro forma statement market value increases over its book customer on December 30, 2017, but of cash flows acts like a budget, telling value and is sold. The capital gain is not they do not pay their invoice until you (or your loan officer) whether you “realized” and therefore not recorded in January 10, 2018, that sale would be will have sufficient cash to continue
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operations each month. It will also Understanding your business’s usual cash services provided while conducting and communicate the assumptions you are flows cycle, and being able to predict negotiating the transaction; as well as making to reach these conclusions. It is future cash flows, are essential to various recording, inspection, and always helpful to have a more becoming a successful business manager. appraisal costs. These costs vary widely, experienced farmer check your projected Cash flows projections will tell you when but can amount to 5% of the purchase cash flows to ensure that your your business might need operating price of the property. assumptions are reasonable and that you financing, or when it’s the right time to FSA and some other lenders can finance haven’t forgotten any cash outflows. hire a new employee or buy new closing costs with your loan, allowing you equipment. Once you feel confident in The statement of cash flows is divided to pay them over time, but usually closing predicting future cash flows for your into three sections: costs must be paid upfront in cash at the business, it becomes easier to plan for time of purchase. Along with a down • Cash flows from operations – inflows changes or growth. payment, closing costs present one of the and outflows from your usual course biggest obstacles to farmers buying land. of business Chattel
• Cash flows from investing – for Collateral farmers, this section usually contains The property or products that one owns, outflows from making capital usually moveable and not attached to Collateral is an asset pledged to back investments in your business, such as real estate. Examples include: your loan, which would be forfeited in buying machinery or a building; it also equipment, livestock, stored grain or the event of a default. Collateral can be includes any cash you receive from vegetables, or vehicles. They’re often any valuable asset, from your car to your selling these kinds of assets used to secure a loan. house to your livestock. A common • Cash flows from financing – includes problem for beginning farmers is a lack of inflows from loans or investments and Closing costs collateral that can be pledged to secure a outflows from paying back loans, or loan. (See secured loans.) outflows from paying a draw to Costs associated with borrowing money owners or dividend to investors and buying land may include loan fees, If you borrow from FSA, FSA officials may which are charged by the lender for make regular “chattel checks” at your Add up all three sections and you have completing the process of originating a farm to make sure that the equipment or your net change in cash flows for a given loan to the borrower; broker and livestock you have pledged as collateral period. attorney fees, which are charged for for your loan is in good shape.
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Unsecured loans, such as credit cards and Cost of goods sold (COGS) general overhead) and keep them some personal loans, do not require you consistent. to pledge collateral. Sometimes called variable costs, the cost Understanding and reviewing your COGS of goods sold are operating expenses is imperative to sound business Conservation easement directly related to the production of the management. Gross profits equals products/services you sell. COGS should revenue minus COGS; so COGS is one of A conservation easement is a voluntary include the cost of labor, inputs and two areas you can improve to better your legal agreement between a landowner materials used, and the portions of gross profits – which is your business’s and a land trust or government agency overhead related to production. that permanently limits uses of the land main indicator of profitability. Small farms are complicated businesses in order to protect its conservation value. for COGS calculations, since there are few Credit report Selling an easement on land with clear distinctions between production, development value can drastically reduce sales, management, etc. For example, in A credit report is a long list of your credit the cost of purchasing farmland, either at any given day your own labor might be history. It shows your debts, how much the time of purchase or afterward. split between harvesting, selling at you’ve paid back, and if you’ve paid late Negotiating an easement is a long market, and bookkeeping – but only the or defaulted. It may include student process, requiring planning, relationship cost of your harvesting labor is included loans, mortgages, credit cards, medical building, and fundraising – but can create in COGS. It can also be difficult to allocate payments, car loans, and any other loans. amazing land access opportunities. overhead costs between production and Your credit report does not always other business functions. You might pay include your credit score. Your credit Read NYFC’s Farmer’s Guide to Working one electric bill for the whole farm, so score, sometimes called your FICO score, with Land Trusts to learn more about how can you differentiate between what is a number that represents this long land trusts and conservation easements. you use in the milking parlor vs what you history and other factors, like the length
of your credit history and the diversity of Cosign(er) use in the office? types of credit. Even professional accountants use
Someone, in addition to farm owners, assumptions to calculate COGS, so don’t Current assets/liabilities who signs your loan, promising to help worry too much about perfect accuracy. pay it back (usually only in case of Define some rules (i.e. 80% of the electric The word ‘current’ implies that an asset default). bill is allocated to production, 20% to
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or liability will be converted to cash or Debt who is calculating the ratio, they may paid in cash, respectively, within one include income from your spouse and off- year. Current assets include assets like Debt is the sum of money that you or farm jobs, or they may limit income inventory or supplies, even annual crops your business owes: to lenders, vendors, strictly to farm income. in the ground or feeder livestock ready or anyone else. The debt-to-income ratio suggests if for processing. Examples of current On the balance sheet, debts are usually financing a property will be affordable for liabilities are the portions of loans that separated into long-term and short-term you at your current income. Speak to a you expect to pay in the next year, or portions, with short-term portions lender to find out what their institution accounts payable due to vendors. coming due within a year. deems to be ‘affordable’.
Current ratio When seeking a loan, lenders will New businesses often need to take on consider both your business and personal debt in order to grow their earnings. In Your current ratio is calculated as indebtedness. Personal debts that show these cases, the debt-to-income ratio will current assets divided by current up on your credit report, such as student improve over time, as debt payments liabilities (See current assets/liabilities.) and car loans, can prevent you from remain constant and your earnings, and qualifying for a loan. For every dollar of obligations due in the hopefully income, increase.
next year, the current ratio tells you how Debt-to-asset ratio Default many dollars of liquid assets you have. This helps lenders understand if your Calculated as total debts divided by total A default occurs when a business fails to business is maintaining enough liquidity assets. The debt-to-asset ratio tells you meet the legal obligations of debt to prepare for unexpected events. what proportion of your assets are owed repayment. In cases of default, the lender A farm’s target Current Ratio depends on to lenders. The less stress you place on usually has some recourse to reclaim its industry. A stable operation with low your personal income to pay debts, the funds or collateral from the borrower. inventory and recurring income, like a more flexibility you will have to take risks. The possibility of default is what drives wholesale dairy, can get by with a lower lenders to take caution in issuing loans, current ratio than a business with more Debt-to-income ratio and why they usually ensure their lenders volatility, like a diversified farm with a have assets that can be seized in case of seasonal retail store. Calculated as current liabilities divided by default. (See secured loans.) total personal income. Depending on
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Depreciation On your balance sheet, asset accounts for out will show up on the financing section your depreciable assets have a of the statement of cash flows. For accounting purposes, it is helpful (for corresponding accumulated depreciation If you do not pay yourself a salary, but accountants and the IRS, at least) to think asset account. As the asset depreciates, you make an income from your farm, of certain assets as having a useful life, its asset account decreases and its then you are paying yourself in dividends. and for their value to decline over a fixed accumulated depreciation account This is fairly common for farmers, but if schedule during that useful life. (See increases. The original cost of the asset you are new to owning a business, be capital expenses.) The accounting should always equal the sum of these sure to consult an accounting method of writing off an asset’s cost over two accounts. professional to determine if you are its useful life is called depreciation. Note that land is not considered a capital paying income taxes properly. Depreciation rates do not, and do not expense, and is not a depreciable asset. have to, reflect how market prices Down payment change over time or even the state of Dividends repair of your particular asset. A cash payment made to a lender at the The most common method for Also called draw or owner’s draw, a time of a property transaction. calculating depreciation is the straight- dividend is a distribution of cash to the Traditional lenders will always require a line method. Determine the useful life of owner(s) of a business. Some farmers down payment to qualify for a mortgage, the asset (some web research or an choose to pay themselves with a dividend often as high as 20% of the property accountant can help with that) and divide instead of a salary, but a dividend is not value. This is one of the biggest barriers the asset’s cost by that useful life. The the same thing as a salary. Salaries have to farmers buying land. result is the annual depreciation expense. payroll taxes deducted and are included USDA’s Farm Service Agency, a farm as a business expense on the income Annual depreciation is an expense that lender, does not require down payments statement. Dividends do not have payroll can be written off your tax bill every year for several of its farm ownership loan taxes deducted – so farmers choosing to you own the asset during its useful life. programs. (See FSA.) pay themselves this way must be careful Contrast that to operating expenses, to avoid tax problems – and they do not which must be written off entirely in the Draw show up on the income statement year they are purchased. because they are not part of the See dividend. operations of a business. Dividends paid
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Easement Enterprise budget of a company: what is left when you subtract its liabilities from its assets. See conservation easement. An enterprise budget is just like a pro For finance purposes: forma statement of cash flows, but for The word equity is used in financial lingo EBITDA one particular part of your business, to represent the value a person has rather than for your whole business. An accrued in a mortgaged property. In line Literally “earnings before interest, taxes, enterprise budget is used to estimate the with the accounting definition, equity is depreciation, and amortization”. EBITDA costs and benefits of undertaking a new the net worth invested in an asset, like is calculated as net profit + interest + project, such as growing a new type of land. You earn equity with payments taxes + depreciation + amortization. crop or building a creamery. If you are toward principal, not interest, and can seeking a loan or investment in your new Why use this complicated figure instead also earn equity if your property value project, you will certainly need to make of plain old net income? Mainly, it is increases. an enterprise budget, but even if you are easier for lenders to compare businesses this way. For instance, an upstart farm financing it yourself this is a useful tool. Building equity is the primary financial reason to own, rather than rent, which recently purchased land may have Examples of enterprise budgets for farmland. With enough equity, you can a large debt burden with high interest different crops and projects can be found qualify for operating loans at better rates, expenses; the upstart will look weaker on Farm Answers and through your local allowing your business to invest and grow than an established farm with no USDA Extension office. when it needs to. Just as important, property debt. Yet by ignoring interest building equity is like using land to store expense – which doesn’t really indicate Equity value. Though your equity may not be as anything about the efficiency of a farm – the lender may learn that the upstart is For accounting/bookkeeping purposes: liquid as an investment account, it still actually more profitable than the Equity, which is often listed as one of has value which can be sold for cash if established farm. three main sections of the balance sheet and when needed. Equity in land, to a as Shareholder’s Equity or Owner’s farmer, can be like a retirement account. Our Land Affordability Calculator uses Equity, is calculated as a company’s total EBITDA to calculate some of the financial Expenses assets minus total liabilities. Equity is ratios presented in the tool, just like your similar to a company’s net worth, and is lender will. There are two categories of expenses: sometimes referred to as the book value capital or operating. All expenses for a
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given period are summed up on the Learn more about FSA and their loan or profit & loss), and statement of cash income statement. programs in NYFC’s FSA Loans Guidebook flows. Each statement is a report or on their loans webpage. containing different financial information Almost any outflow of money from a about your company. Financial farm business can be considered an Financial ratios statements can be historical, looking expense. One major exception is the backward at your business finances; owner’s draw/dividend, which should not Financial ratios are equations used by snapshots, looking at your finances at a be considered a business expense and is lenders and investors to judge the particular moment in time; or projected, not included on the income statement. creditworthiness of businesses and looking forward to estimate future
business plans. They are also valuable financial scenarios. Farm Credit tools for business managers to help understand the success of their business Fixed interest rate Farm Credit is a nationwide network of or the viability of their plans. customer-owned lending institutions, In contrast to a variable interest rate, a specifically for agricultural finance. Learn Scoring “well” on any particular financial fixed interest rate remains the same over more and identify your local branch at ratio should not be the goal of any the amortization period of a loan. their website. business or business plan. Good loan
officers and investors take time to Graduation Farm Service Agency (FSA) understand businesses and the people behind them. They can tell you which A term FSA uses when a farmer The Farm Service Agency (FSA) is a part of ratios your business scores well on, and refinances their FSA loan with a loan from the USDA tasked with providing a wide how to improve the financial outlook in a traditional lender, with or without a range of services to farmers in America. those areas that need improvement. guarantee from FSA. Graduation is the One of their core offerings is a robust, FSA’s goal for their farm ownership loans. low-interest farm loan program that is Financial statements
accessible even to farmers who cannot Gross income / Gross profit access credit elsewhere (technically only The three most common financial to farmers who cannot access credit statements that you will be expected to You may hear it called gross income or elsewhere). create and understand are the balance gross profit, but it’s the same concept. sheet, income statement (also called P&L Though easily confused with both gross
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revenue and net income, gross profit is $136 billion in revenue, Amazon booked owner’s draw. Note the difference not the same as either. Gross profit is a gross income of over $47 billion and a between gross margin and profit margin. gross sales minus the cost of goods sold net income of about $2 billion. So, Gross margin can be used in tandem with associated with those sales. Amazon’s core operations are profitable, profit margin to analyze your business. If Note that the sales side of the equation with a gross margin of 35%, but they your profit margin is low, is it because does not include non-operating revenue, must be using those profits to support your gross margin is also low? If so, you such as that earned by selling off old other big expenses outside of their main should focus on increasing revenue equipment or income from loans. It operation, such as R&D. Investors trust and/or reducing production costs. If should only include revenue from your that Amazon’s huge expenses outside its profit margin is low but gross margin is operations. Similarly, the cost side only costs of goods sold will lead to future high, then you should focus on reducing includes cost of goods sold, not other profits, so they continue to salivate over overhead, debt expenses, or dividends. cash outflows, like capital expenses or this growing company. However, without dividends. the context of knowing that Amazon was Work with your lender or another reinvesting its profits into creating new business advisor to determine what a Why look at gross profit separately from business enterprises, by the numbers “good” gross margin for your business net income? alone Amazon might look like a bad bet, should be. This is highly variable based on Looking at a business’s gross profit with a profit margin of 1-2%. what you’re producing, where/how you should help you understand the sell it, your debt level, how you pay For your own purposes, remember: while profitability of its core enterprise(s), yourself, and your business’s scale. both gross profit and net income are independent of other factors, such as its important, net income is primarily built debt load. It’s a subtle difference, but Gross revenue on gross profit. important to grasp.
Gross revenue is the total money Think about a famous corporation like Gross margin generated by the farm. It includes all Amazon. Amazon is notorious for turning sales receipts from operations, as well as out very little profit, despite its enormous Calculated as gross profit divided by gross cash inflows from loans and non-farming operation. When someone says that revenue. Gross margin is the percentage sales, such as selling off old equipment or Amazon has low profit or no profits, the of your revenue that can be used to pay renting out on-farm housing. person is talking about net income, not back loans, pay for overhead expenses, gross income. For instance, in 2016, with reinvest in the business, or take an
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Looking at a farm’s gross revenue can tell Income statement (P&L) Interest you something about its size, but nothing about its profitability. Both are important Also called a P&L, for ‘profit and loss’, this What a lender charges its borrowers. to lenders and investors (and certainly to financial statement reports on a Interest and principal payments are the farmer). Make sure you know the business’s performance over a given bundled together in each loan payment. difference between gross revenue, gross period, usually a year. Interest represents a larger portion of income, gross margin, and net income; your loan payment early on in the loan, Income statements cover a business’s they may sound similar, but these figures decreasing as you make payments. In this entire finances – revenues from selling all represent something different. way, you earn equity slowly at first, then products/services and operating quickly later in the amortization period. expenses like cost of goods sold, along Guaranteed loan with non-operating income and Interest-only loan expenses, such as income from a loan or A loan guarantee is an insurance-like the investment in a new facility. These arrangement that one lender can offer to Conventional loans are structured with sections should be separated so that the another lender to build a loan package. equal, usually monthly, installments of reader can understand your business’s Farmers will encounter this arrangement principal + interest paid over the operational profitability, or gross income, most often when borrowing from FSA. amortization period. Interest-only loans versus your overall profitability, differ from convention by requiring the FSA offers several guaranteed loan represented by net income. borrower to pay only the interest portion programs. In each, a USDA-approved Some lenders will use your tax records of the loan for the first several years, with lender offers financing at reasonable (Schedule F) as a replacement for an a large “balloon payment” scheduled for interest rates to the farmer in exchange income statement. This workaround can the end of the interest-only period. for a guarantee from FSA that it will be fine for their needs, but not Instead of actually paying the balloon compensate the lender in case of default. necessarily for yours. The income payment, often lenders plan for you to Guaranteed loans allow lenders to share statement is formatted for business refinance the loan at that time. risk and expand the pool of funding analysis. Use your income statement to Interest-only loans are helpful financing available for farmers to borrow. learn where your biggest income and tools for borrowers who cannot handle expenses come from; it will help you monthly payments now, but will be able make better planning decisions. to in the future. Some FSA loans are
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designed this way to help farmers align provider familiar with lease-to-own Farm Service Agency Loans: The Ins and their loan payments better with transactions. Outs of Growing a Farm with Federal agricultural cash flows. Loans. There are many ways lease-to-own can
be structured. The farmer can hold an Land trust Leverage option to purchase, sometimes until a
Land trusts are non-profit organizations particular date or for a particular amount, Leverage is the amount of debt a founded to protect natural resources, or the farmer could just have the right of business is using as a tool to increase such as farmland, from development or first refusal, meaning the landowner growth, like using a crowbar as a lever to damage. Land trusts may be able to help would have to offer the purchase open something. (See Solvency.) farmers locate land, provide them with a opportunity to the farmer before putting secure lease, or reduce the cost of land it up for sale. The lease-to-own Liabilities arrangement can be between the farmer ownership by purchasing an easement. and previous landowner, or a third-party Liabilities are debts or any other kind of Read NYFC’s Farmer’s Guide to Working investor can act as an intermediary, financial obligation incurred by your with Land Trusts to learn more about buying the property from the previous business. They are one of the three major land trusts and conservation easements. landowner and leasing it to the farmer sections of the balance sheet. Some until the farmer can make the purchase. examples of liability accounts include Lease-to-own notes payable, accounts payable, and Lender long term mortgage payable. A lease-to-own scenario can be a good option if you want to own property in the Lenders vary greatly in their experience Liabilities can be considered either long- future, but cannot access sufficient offering farmers loans. Farm Credit and term or current/short-term. Current financing now. In this land acquisition the USDA Farm Service Agency are the liabilities need to be paid within a year. model, the farmer leases the farm they primary farm loan providers in the US. For a long-term debt like a mortgage, you want to buy until they are able to Other worthwhile local lenders include would treat the next 12 months’ amount purchase it. These are usually banks, credit unions, or community due as a current liability and the rest as a complicated transactions that should development financial institutions. long-term liability. Separating short-term involve legal assistance, and probably from long-term liabilities on the balance also guidance from a farm service To learn more, speak with local farm sheet helps the reader understand if your service providers or read NYFC's guide, business is able to pay off its current
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liabilities with its liquid assets, such as already have a lien against it. For must be liquid day-to-day to continue cash. instance, if you’re paying off a car loan, operations. you might not be able to pledge that car Liabilities should not be confused with as collateral when applying for an FSA Market analysis expenses. Liabilities are part of the loan. balance sheet, while expenses show up The market analysis section of your on the income statement. Expenses show Liquidity business plan describes your customers the costs you have incurred, while and the market they comprise. You can liabilities are future obligations incurred. Liquidity describes an asset’s degree of focus on the size and characteristics of Indeed, by incurring some liabilities, your transferability. Cash is perfectly liquid – the market itself, or on describing your business actually receives cash – like you can use it to buy anything. That’s target customer specifically, or more when you receive a loan. why we set our prices in dollar units. Your likely, both.
walk-in refrigerator may be a valuable Lien Your market analysis might include: asset, but is less liquid than cash because it would be difficult to exchange it for • Statistics about the size, growth rate, The legal claim that a lender has on real another asset. and trends in your market estate or other property until a debt has • Details about your target market, been repaid. For example, in a traditional Liquidity can be used to think about a including their average income levels, mortgage, the bank has a lien on the business in general, rather than a specific shopping preferences, motivations, property. If you default on your loan, the asset. Even a profitable business could be and the size of this subset of the lender may have a legal right to seize illiquid. For example, maybe you make market your liened asset. (See secured loans.) plenty of restaurant sales, but your • Any market research you’ve done, or customers have not paid their invoices. Sometimes a particular asset can have can find about your industry Your income statement would show a multiple liens against it, with a priority • Analysis of your competition healthy gross income, but a look to the order of which lender would be paid back • Barriers to entry into this market, such balance sheet might show a big accounts in case of default. Different lenders have as regulatory requirements receivable account and no cash. different rules regarding their lien rights, Unfortunately, you can’t use accounts so be sure to be upfront with your loan receivable to pay your bills! No matter officer if there’s a chance that an asset how profitable a business is in theory, it you’re pledging as collateral might
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Microloan before applying for a loan to learn more Operating expenses about your creditworthiness. A small loan (FSA’s microloan program Operating expenses are those expenses Some lenders, like FSA and Farm Credit, maxes out at $50,000), often provided incurred through “normal business are more familiar with farm mortgages. with looser eligibility requirements or less operations”. This is a more expansive
paperwork, and sometimes coupled with definition than cost of goods sold, which Net income technical assistance. Micro-lenders can only represents the costs related to be community based, though the term is production. Indeed, operating expenses Net income equals gross revenue minus also used to describe crowd-sourcing are usually considered the sum of COGS; total expenses. It is the bottom line of the platforms, like Kickstarter, or peer-to- selling, general, and administrative income statement. peer lenders, like Kiva. expense (or overhead); and depreciation Note the difference between net income expense. Mortgage and gross income, which only describes a Contrast capital expenses with operating business’s income from operations. expenses. The two are generally treated A legal agreement in which the lender There are other expenses that affect your differently by the IRS because of the agrees to give the borrower money to bottom line, such as taxes, an owner’s long-term nature of some assets. purchase an asset, and the borrower draw, or interest payments – none of Operating expenses are written off of agrees to pay the lender back over a fixed which is reflected in gross income, but all your net income in the year you make amortization schedule. Each loan of which are included in net income. the purchase because operating payment includes a portion of principal Take caution: a positive net income alone expenses are for items or services that and a portion of interest. Mortgages are does not prove a profitable business are consumed within a year. Capital secured loans in which the lender can operation. Net income includes revenues expenses are made on long-term assets, seize the asset in case of default. from financing and non-operational and so are generally written off over time To get a mortgage from a traditional revenue, such as from selling property. by deducting a depreciation expense lender, you will likely need to contribute Just because a business shows a positive each year until the asset depreciates to a down payment and pay closing costs at net income does not mean the business nothing. That’s why, in our operating the time of the transaction. Different operation was successful for the period expenses formula, we include lenders vary greatly in their eligibility under observation. depreciation expense – to write off the criteria for loans; check your credit report portion of depreciation on capital assets
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along with all the operating expenses Overhead Principal made that year. Overhead is a catch-all term that Principal is the face value of a mortgage, Operating loan generally covers any operating expenses or of any loan. It is the original amount not included in cost of goods sold and borrowed from the lender. The more Agricultural businesses generally incur depreciation expense. You might also principal you pay back, the more equity operating costs before a product can be hear the term ‘fixed costs’ used for you earn. sold – often years in advance. An overhead. Examples of overhead include Loans are usually structured to be paid operating loan can cash flow your utilities, rent, and insurance expenses – back in equal monthly or annual operation in advance of sales. Some farm but even those are not always overhead. installments. But since interest is charged businesses, especially those growing For instance, if you track your electric on outstanding principal, as you pay back commodity crops, rely on seasonal bills by building, the creamery’s electric the loan, even though each payment is operating loans to buy seed, fuel, bill would be part of COGS while the constant, an increasing amount of your fertilizer, and other inputs before the office’s electric bill would be overhead. payment goes towards principal. That growing season; then they pay back their Think of overhead as what you would still means you build equity faster later in the loans with proceeds from the harvest. have to pay for even if your business amortization period, because more of Operating loans generally have short produced a very low volume of product. each payment is devoted to principal. amortization periods, often as short as That is a complicated concept, but even if one year. Owner-operator at first glance you don’t grasp how it CSA is a sort of informal operating loan, works, you should know why it’s One who owns the farm business and the in which the farm’s customers pay for important. Making extra principal farmland, and contributes to the products in advance of receiving them. payments on a loan is the best way to management, labor, and capital to run reduce the total cost of that loan because A business with a strong credit history the farm. A tenant-operator is the same, an extra payment toward principal also can qualify for a line of credit at a bank, but leases the land instead of owning it. reduces the interest you would have which pre-approves the business to take been charged for that principal. For out an operational loan from the bank at Owner’s draw people who don’t invest in stock markets, any given time. an extra mortgage payment is often the See dividend. best investment you could make.
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Profit margin Promissory note Repayment capacity
Profit margin equals net income divided A document that promises payment of a Repayment capacity is your ability to by gross revenue. Profit margin can also debt by a certain date. Also just called a support your business/living expenses be calculated on an enterprise basis if note. and debt payments while reasonably you wanted to analyze the profitability of saving for the future. The debt-to-income one particular line of business. Refinance ratio is one way of measuring repayment capacity. Remember that profit margin suffers the Refinancing is replacing one loan with a same limitations of net income as a new loan, for any reason. First-time Return-on-assets ratio measure of farm success. Since the buyers might not have had great credit or calculation includes all revenue, not just weren’t able to make a large down Return on assets measures net income operating revenue, profit margin alone payment, so they only qualified for a loan (adjusted for certain factors) divided by cannot tell you whether the business had with a high interest rate. After additional total business assets. It tells you how a successful year, or just happened to years of making on-time payments, they efficiently you are utilizing your assets to receive financing revenue from a loan may qualify for a better, cheaper rate by turn a profit. It is one of many financial that year. refinancing. ratios used by lenders to assess your creditworthiness. Pro forma You can work with some lenders to take advantage of refinancing as an Agriculture tends to be an asset-heavy This term refers to the manner in which a affordability tool. For instance, if you industry. However, not all farms require financial statement is prepared, implying need a loan to grow your operation, you loads of assets to turn a profit. Smaller the statement is future-looking. Pro can start with an interest-only loan, and scale direct-marketing farms, especially forma statements rely on estimates to plan to refinance with a conventional those that rent land, will have small asset show how a business decision would loan once your business grows and you bases and therefore should target a impact the finances of a business in the can afford the payments. higher return-on-assets ratio if they want future. Contrast these with ordinary to be competitive with more asset-heavy Refinancing can also be a way to access financial statements, which document farms. the equity you’ve earned, to use towards historical financial data. other investments.
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Schedule F you financing to buy their property. This FSA, the “lender of last resort” which is arrangement can work well for a retiring often the farmer’s “lender of first Also called Form 1040, this is the IRS farmer transitioning their land to a opportunity.” form for reporting farm income and younger farmer. The buyer and seller expenses. It is similar to an income would execute a promissory note Value proposition statement, but specifically formatted for detailing all the major aspects of a loan: tax reporting purposes. interest rate, amortization period, This is the core of your business plan and payment schedule, and consequences of strategy. Your value proposition is the Secured loan / Unsecured loan default. As may be obvious, these value you’re promising to deliver to your agreements require a high level of trust customers. It should summarize why a A loan is considered secured if the lender and legal assistance. customer would want to purchase has a lien on the borrower’s property, something from your specific business, For farmers having trouble accessing land which can be seized in case of default. In rather than a competing offering. to start or grow their business, short- an unsecured loan, the borrower pledges no collateral; unsecured loans are usually term seller financing can help you get Variable interest rate started until you can qualify for a loan only offered in small amounts or to borrowers with very good credit. A and refinance with a traditional lender. The interest rate on a loan could be fixed Compare this strategy with lease-to-own. mortgage is a type of secured loan; a for the entire amortization period, or set credit card is a type of unsecured loan. FSA offers a loan guarantee program for to change along with a benchmark seller financing transactions. market rate. In these variable interest Security rate loans, your loan payment will change Solvency if the benchmark rate changes. Property of any type that is pledged to Mortgages with variable interest rates back your loan. Also called collateral. A solvent business has enough assets to are usually called ‘adjustable-rate cover its debts. (See Leverage.) mortgages’. Seller financing Whether or not choosing a variable rate Traditional lender Instead of getting a farm ownership loan loan turns out to be a good deal for the borrower simply depends on how the from a traditional lender, you may be Banks, Farm Credit institutions, credit benchmark rate changes over time. able to find a landowner willing to offer unions. This term is used to contrast with
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Write off especially when considering large capital investments. This phrase is thrown around often, and ‘Write-off’ can be used somewhat is frequently misunderstood. ‘Writing off’ interchangeably with the term an expense means subtracting it from ‘deduction’. Usually, deduction is used in your revenue when determining your the context of personal tax filings, taxable income. Writing off an expense whereas write-off is used for business does not make it free; rather, if you have accounting and taxes. Both write-offs and taxable business income, it reduces your deductions are different from tax credits, tax burden by your tax rate multiplied by which directly reduce your tax burden the amount of the expense. and can even result in tax refunds. Write-
Operating expenses and capital expenses offs and deductions only reduce your
are meant to be written off differently. taxable income, indirectly reducing your
Operating expenses get written off in the tax burden in profitable years, but never
year in which they are incurred; capital triggering a refund.
expenses are depreciated across their
useful life, then a correlating Acknowledgements depreciation expense is written off each year until the asset is fully depreciated. This project is supported by a grant from However, in recent years the IRS has the USDA National Institute of Food and allowed businesses to fully depreciate Agriculture through its Beginning Farmer qualifying capital expenses (up to and Rancher Development Program, $500,000) in the year in which they are #2016-70017-25499. incurred to stimulate business investment – even in a very profitable Special thanks to The Carrot Project and year, an investment like that could write the Rural Advancement Foundation off your entire tax bill. Make sure you International – USA, whose glossaries work with an accounting professional, were referenced during the creation of this publication.
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