Usually, you can see the potential for a wreck well before it happens - whether you are driving your car or managing your farm finances. On the farm, keep an eye out for these signs of a potential financial wreck:

The checkbook doesn’t stretch enough to pay the bills.
If you can’t pay your bills and ongoing expenses, you’ve got trouble. This includes living expenses as well as ongoing farm expenses. And while it seems obvious, it’s easy to ignore and think that things are going to get better on their own.

Carrying open accounts past 60 days.
Carrying open accounts with vendors can be a smart way to manage cash flow, but if you have to stretch your payables too far, that’s a sign that something’s wrong with your cash flow.  Carrying open accounts for too long can make you an undesirable customer to important input suppliers, setting you up for future problems.

Forgoing necessary inputs.
This seems like a no-brainer, but too many farmers skimp on feed, water, fertilizer, and other necessary inputs because they don’t have the cash to pay for them. As a result, crops and livestock don’t perform as well as they should, so income goes down, and then, next year, you’ve got even less money to pay for the necessary inputs. And the cycle repeats itself, getting a little worse each time.

Selling inventories.
To create short-term cash, you might be tempted to sell input inventories that you will have to replace later. The same thing is true when it comes to selling CSA shares in the fall to generate fall cash-flow - you’ll likely find yourself in the same situation next year unless you make some changes to your operation. This is almost always a losing proposition.

Accepting lower-than-market prices.
If you have to sell your products at lower-than-market prices to generate short-term cash, that’s a sign that things aren’t going well. You should be selling products to make money, not just to plug cash-flow holes.


Avoiding the Wreck

If you identify hazards early enough, you can take actions to avoid them. But it’s important to act fast.

Talk to your lender immediately.
No, really, don’t wait! Most borrowers hide financial problems from their lenders until it’s too late, but hiding problems from partners – whether they’re business partners or personal partners – is never a good idea. Remember, in most cases, the bank simply does not want your farm – they will work with you to figure out how to avoid having a bad loan on their books. And it’s easier to make adjustments when the crisis point is further away, rather than waiting until you’ve washed up on the rocks.

Change the amortization on your loans.
Cash flow isn’t everything, but it is an important thing. Changing the term of a loan can be a win-win for you and the bank, since they don’t end up with a bad loan on their books and you can reduce your monthly payments. And, of course, if things get better, you can always increase your payments back to their original level.

Consider a line of credit.
A short-term infusion of cash with a payback plan is usually a much better option than having a dozen vendors banging on your door and ringing your phone wondering when they are going to get paid.


Increase Success

This is perhaps the most important way to avoid a wreck!

In agriculture, profitability has three components: scale, costs, and utilization.

You need to produce enough product to cover your overhead expenses. It costs the same amount of money and time to have a website or write a newsletter whether you sell $1,000 worth of carrots a week or $50,000. And many variable costs have a certain baseline to them - trucking and handling charges are often based on the pallet or the truckload, regardless of how much product is on the pallet or in the truck. The number of pallets is a variable cost, but each pallet costs the same whether it's carrying $300 or $3,000 worth of product.

You need to drive down your cash expenses as much as possible. Don't skimp on the water and fertilizer that make your crops grow, but don't pay more for them than you have to - unless paying more for them provides value in another way. (I try to buy my tools locally, and pay more for them than I would at the big box store, because my local hardware store provides tons of help and advice with smaller purchases; I buy seeds from a high-quality vendor rather than getting the sweepings from the seed room floor from a cheaper source.)

You need to maximize utilization of your assets - all of your assets. If you are in the crop production business, every acre needs to be working for you, whether it's growing a cash crop or next year's fertility. If you have employees, you need to maximize their productivity. If you are selling meat, you need to maximize your use of the entire carcass, getting the best price on every part of the animal. In the delivery business, your trucks need to run as many days a week as possible, and as full as possible whenever they are running.

Most often, the changes that growers need to make in order to avoid a wreck come from improved management, rather than significant investments. Focus on investments that increase your ability to monitor the critical elements of your operation – most of these can be had at very little cost.


Don’t Wait for the Warning Signs

Of course, if everything in your operation is going great, you probably won’t have anything to worry about. But just like your car can seem to be running just fine right up until your tire blows out, farm financial troubles have a way of sneaking up on you. The best way to avoid a financial wreck is to look out far in advance. And the best way to do that is to institute a regular pattern of financial planning and monitoring.

• Weekly - Are there bills to pay? Do I have money in my bank account? What’s my credit card balance?
• Monthly - Are there any outstanding receivables? Does the bank think I have as much money as I think I have? How is my financial plan working out?
• Quarterly - What do I owe the government for payroll and other applicable taxes?
• Yearly - What do I owe the government now? How have my assets, liabilities, and equity changed in the last year? Did I make progress last year?

Every year, farm businesses should complete a balance sheet, income statement, and statement of cash flows, and evaluate the resulting financial ratios. These reports provide invaluable feedback on business progress from year to year, as well as predicting issues that are coming down the pike.

In addition, creating an ongoing financial history of your farm with these statements will not only demonstrate business growth, it will also demonstrate to a lender/investor that you take your business seriously; one of the primary complaints I have heard from lenders is that they are being asked to finance lifestyle choices under the guise of a business investment.

I think it’s fair to say that most of the success factors in market farming can be described in a bell curve. As the bell curve implies, most of us have okay access to markets, and we farm ground that’s okay for market farming. We have okay business acumen, okay marketing skills, okay land-access arrangements. Our available labor is largely okay, we have okay innate organizational skills, and okay willpower to get out there and get the right work done on the right day.

Most of our models in farming, however, have something more than okay: they’ve got several factors located far out to the right on the bell curve. They’re located close to concentrations of wealth and enthusiasm for social righteousness and good food. They got into the market at just the right time. They inherited land or bought it on the cheap. They acquired business acumen in another line of work. They discovered what they wanted to do early in life and had a few dominoes tip in just the right way. They’ve inherited or developed the traits that help them stay organized, intuit what needs to be done, and relate well to people.

That’s not to say that our models don’t work hard, develop new skills, enhance value, innovate, and do a thousand other things right day in and day out. If you’re going to succeed in this business – any business! – you’ve got to do a lot more than get lucky. And “getting lucky” is almost always a function of hard work and smarts in addition to having life’s dice roll your way. “Making it” in market farming, especially over the long haul, is never handed to you on a silver platter. (If it is, I haven’t seen an example.)

But it does mean that many of our models in farming can get away with things that those of us without a stack of lucky breaks at our backs can’t. They can get away without a monthly cash-flow budget, or filling out financial statements, or getting a line of credit at the bank. They don’t need to understand financing because they don’t have to incur debt in order to reach their goals. They don’t require a system for employee management because it just comes naturally to them.

The rest of us need to stack the deck – and the best way to stack the deck is to increase the intentionality that we bring to the management of the farm. And that means increasing our use of the plan-monitor-control cycle.

And if there’s one area that drives everything else when it comes to management, it’s money. Because money is the bottom-line expression of value and ability to continue farming in our world. That’s not to say that money has to guide everything you do, but money provides the foundation that allows every other expression of our values to be present in the world. It allows us to farm another year.

And this time of year – right now, as a matter of fact! – is the best time to put together the three key tools you need to monitor your farm’s financial performance: a balance sheet, an accrual-adjusted income statement, and a statement of cash flows. As we move towards the start of the new year, it’s the perfect time to take inventories of our supplies, and set aside an hour on New Year’s Eve to check balances on our bank accounts, accounts receivable and payable, loans, and credit cards.

These three tools, conventional as they are, can provide insights into your farming operation, especially when compiled year after year, when plugged into various farm financial ratios, as described in resources such as this Farm Financial Scorecard. Tracking these year after year can provide not only important measurements of your farm’s performance, they can also help diagnose problems and provide an early warning of negative trends in your business.

(Please see the October and November issues of Growing for Market – available here if you don’t subscribe already – for my articles on assembling financial statements, as well as the book, Fearless Farm Finances, which I coauthored.)

When a company buys your product to sell it to somebody else, they charge more to their customers than they pay you - that's how they cover their own expenses, and how they make money in return for their management expertise, risk, and investment.

The additional amount they charge can be expressed in two different ways: as a markup, or as a margin. A markup describes the additional percentage a reseller makes on the product, whereas a margin describes the percentage of the selling price that a reseller makes over and above the price they paid for it.

Understanding margins can help you estimate the price a store or wholesale distributor is paying for their product. Margins are also part of the language of the trade, so understanding margins puts you on a more professional footing when you talk with buyers.

Margins are useful because they describe the "gross profit margin" that a reseller actually gets. The margin has to cover all of the reseller’s expenses related to selling produce. For example, natural food stores in my area use a 42% margin as their basis for calculating retail produce prices. That 42% of their selling cost has to cover all of the store's direct expenses related to selling produce: the labor, bags, and display items, as well as the overhead costs of running the store: electricity, rent, bookkeeping, cash registers, and everything else.

In other words, if the store is charging $1.00 for a bunch of parsley, they’ve got $0.42 to cover all of the costs of selling that parsley, because they spent $0.58 to purchase it for sale in their store.

And, even though they use a 42% margin to calculate their prices, they expect to realize only a 35% margin on their produce sales overall, since they lose a certain amount to "shrink," due to spoilage, trimming, blemishes, customer handling, and so forth.

Different outlets have different cost structures, so they use different margins.

A wholesale distributor I've worked with uses a standard margin of 23%. They have lower expenses per unit sold than a retail store does, so they don't need to charge as high of a margin.

In fact, different product lines in a grocery store also have different cost structures, so the margin on canned goods is going to be different than it is on fresh produce, since canned goods don't have the same risk of spoilage and don't have the same labor requirements as fresh produce.

And that's where margins matter to market farmers. When you have higher selling costs, you need a higher margin. When you sell produce at farmers market, your costs - labor, stall fees, shrink - are higher than your cost to sell to a retail store. If you sell at a retail store and at a farmers market, your prices in each of those markets should reflect your costs in each of those markets. It costs the same amount of money to grow a bunch of kale for your farmers market stand as it does to grow a bunch of kale for a retail store, but it costs a lot more to sell that bunch of kale at a farmers market.

We'll continue this topic next week when we get into margin math, so stay tuned!

In agriculture, profitability has three components: scale, costs, and utilization.

You need to produce enough product to cover your overhead expenses. It costs the same amount of money and time to have a website or write a newsletter whether you sell $1,000 worth of carrots a week or $50,000. And many variable costs have a certain baseline to them - trucking and handling charges are often based on the pallet or the truckload, regardless of how much product is on the pallet or in the truck. The number of pallets is a variable cost, but each pallet costs the same whether it's carrying $300 or $3,000 worth of product.

You need to drive down your cash expenses as much as possible. Don't skimp on the water and fertilizer that make your crops grow, but don't pay more for them than you have to - unless paying more for them provides value in another way. (I try to buy my tools locally, and pay more for them than I would at the big box store, because my local hardware store provides tons of help and advice with smaller purchases; I buy seeds from a high-quality vendor rather than getting the sweepings from the seed room floor from a cheaper source.)

You need to maximize utilization of your assets - all of your assets. If you are in the crop production business, every acre needs to be working for you, whether it's growing a cash crop or next year's fertility. If you have employees, you need to maximize their productivity. If you are selling meat, you need to maximize your use of the entire carcass, getting the best price on every part of the animal. In the delivery business, your trucks need to run as many days a week as possible, and as full as possible whenever they are running.

On March 14, I’ll be presenting a workshop on employee management for the Practical Farmers of Iowa. And while good management can make the difference between making headway on your farm's work or just creating headaches, the legal side of farm employment is almost guaranteed to lead to headaches, especially for market farmers.

Because it requires large injections of seasonally-intense labor, as well as having a legitimate reason to offer employees housing, farm work is often subject to slightly modified set of labor laws and regulations. Unfortunately, it can be difficult to find concise answers in one place to all of the questions these exceptions raise. And for market farmers, the issues get even more complicated because many of the activities we engage in – such as cleaning, packaging, selling, and delivering produce – don’t fall under the traditional (and legal) definition of farm work.

Practical Farmers of Iowa, working with the nonprofit law center Farm Commons, has created a Farm Employment FAQ, with answers to many of these difficult questions for Iowa farmers, available here.

Farmers’ Legal Action Group has created a printable guide for Minnesota farmers, available here.

Kudos to both of these organizations for creating accessible information for this critical and often misunderstood area of farm management.

If you know of similar resources for other states, we’d love to hear about it in the comments.

A few people actually enjoy bookkeeping. For most of us, it’s a tedious job that we have to do, and all too easy to put on the back burner since it doesn’t produce the same visible, visceral results that building a fence or harvesting carrots does. Since it’s such an easy job to put off, it doesn’t take long to create a seemingly insurmountable pile of stuff with something scary likely lurking somewhere in the middle of it – and you don’t want to find yourself behind on paying bills when the weather’s finally right for killing weeds.

Fortunately, modern bookkeeping tools and a good system for using them can make a big difference when it comes to cranking the bookkeeping widget. December is a great time to set up a new bookkeeping system, or revamp your old one, since the fiscal year starts on January 1, and you want to input your data in a consistent way throughout the year.

A successful bookkeeping system has three important outcomes: facilitate cash flow budgeting, monitoring, and decision-making throughout the year; make it easy to analyze profitability; and provide documentation and data for taxes. Contrary to the way many bookkeeping systems are set up, the last of these is the least important. – completing a schedule F is a once-a-year event, and the data can be easily extracted from a good bookkeeping system that is organized around the priorities of providing you with the information you need.

A successful bookkeeping system also has to be easy to use. Most farmers I know do their own bookkeeping, and even if you don’t, good bookkeepers don’t come cheap. That means you need systems that facilitate fast data entry and filing with a minimum of thought, especially if you are prone to doing bookkeeping after the field work is all done, or with a beer in hand.

I use QuickBooks for my bookkeeping, and will refer to it throughout this article. I’ve looked at other bookkeeping software, and I know that everybody has their preferences, but I keep coming back to QuickBooks because it’s the industry standard. You can use the same organization and workflow described in my Growing for Market article with any bookkeeping system.

The rest of this article is available from Growing for Market, as part of the November/December issue.

I often find that it's the little things that make or break my attitude. Big problems I can handle, but something like not having the address on a pre-printed check show up in a window envelope will truly drive me crazy.

Of course, sometimes it seems like the world was designed to make me crazy.

Printed checks - the kind you can run through your computer printer after inputting the data in QuickBooks - are just enough smaller than one-third of a sheet of letter-sized paper that the addresses don't reliably show. You need a different-sized envelope than the one you might use for invoices to make it show just right.

For invoices that we send out, we use a double window #9 envelope - these measure 3-7/8 x 8-7/8 inches.

For checks, we use a double window #8-5/8 envelope, measuring 3-5/8 x 8-7/8. And, yes, that 1/4 of an inch makes a real difference.

Because I live in the humid Midwest and don't have air conditioning, I vastly prefer peel-and-seal envelopes to the press-and-seal type; this allows me to buy in lots of 500, even though it might take two years for me to use them up. For some reason, their availability through Amazon and the big box office stores seems to limited, which frustrates me to no end. It occurs to me that maybe I should store my backstock in my onion- and seed cooler.

In a farm's bookkeeping system, distinguishing between revenue expenses and capital expenses matters. In my visits with beginning farmers, I often find these two items blended together.

• Revenue expenses are those expenses associated with the day-to-day operation of the business;
• Capital expenses apply to the purchase of assets such as property, buildings, or equipment - fixed assets with a long-term use.

Because revenue expenses are associated with the day-to-day operation of the business, they are incurred every year. Capital expenses are incurred infrequently, so they don't reflect on the profit performance of the business in any one given year. It is important to track them separately.

Capital expenses *are* accounted for each year using depreciation. Under current tax laws, business owners can "depreciate" some capital expenses in a single year; however, this doesn't mean that the entire depreciation expense should show up in your income statement. (An income statement allows you to calculate your farm's "net farm income," or the amount of "profit" your farm gave you over the past year in return for the labor, expertise, and capital you invested in it; it is the key measure for comparison of year-to-year financial performance.)

Many business owners confuse the amount of depreciation taken for taxes with the depreciation requirements of an income statement. The depreciation taken on an income statement should represent the actual change in value of the asset in a given year. You can calculate this with the following formula, in which the salvage value is the price you could get for the equipment after the life of the investment:

While depreciation can be a good approximation of the capital expenditures necessary to maintain the asset base of your farm, this is not necessarily the case for new and rapidly expanding operations, where large initial investments are required. As the business stabilizes, the approximate value of the assets that need to be replaced each year should be represented by depreciation; a profitable, sustainable business needs to plan for asset replacement.

Keep in mind that capital expenses do have an impact on cash flow. In your cash flow budgeting process, you need to account for the capital expense in the year that you spend the money. But when you assess business performance, use the formula above to calculate that expense.

When Jack Hedin called me last summer to ask if I would take a look at some transplant production issues Featherstone Farm was having in their greenhouses, I had no idea or expectation that, one year later, Featherstone Farm would occupy such a large part of my time and attention. It’s been a great year, with many exciting and engaging challenges.

In over twenty years of working on and with organic vegetable farms around the country, including thirteen years of farming on my farm, I’ve noticed that most farms and their farmers just plow ahead, making decision after decision on what action to take next to keep the irrigation pumps running, the harvest crews picking, and the tractors in motion without consideration for larger impacts or processes. The race against the weather and the perishable nature of vegetable crops combine with scarce time and monetary resources to create a situation where farmers never get a chance to stand back and evaluate their operations, much less the time to make systematic and systemic changes to build the foundation for future improvements.

It reminds me a bit of parenting.

We put a lot of effort last winter into a rewritten business plan and refinancing. But just as importantly, we worked hard to put processes in place for the financial management of the business on an ongoing basis. Featherstone  Farm now has not only a financial plan, it has a system in place for the periodic and timely monitoring of performance to that plan, as well as mechanisms for making corrections and replanning as necessary. Each month, the leadership team meets to review the farm’s income and expenditures relative to the plan – then, where things are not going right, we figure out how to correct them and assign responsibility for following through.

Weekly meetings of the leadership team provide an opportunity to check in and get everybody on the same page about progress made on addressing those financial issues, as well as other issues on the farm. The CSA team meets on a schedule to decide what’s going in the box and what’s going in the newsletter. And every Friday morning, the entire crew has a short stand-up meeting to make certain that everybody’s on the same page about the little and big things that keep the farm running smoothly, from rolling the windows up on the farm trucks and holiday work schedules to the process for reporting accidents and injuries and the importance of communication and teamwork to the farm’s success.

Farming is governed by rhythms and interruptions. We plant, cultivate, and harvest in cycles and patterns big and small, seeding onions in at the end of winter, harvesting lettuce in the cool of the morning. We weather floods and droughts, scramble to solve personnel crises, and shuffle the resources we need to get a critical piece of equipment repaired while the rest of the farm keeps running. And while weekly staff meetings and monthly financial reviews may be a part of many businesses, these larger patterns – independent of nature’s cycles, and recognizing the interface of agriculture with the larger culture of individuals, finance, and governance – occur all-too-rarely in the world of organic and local farming operations. To have the opportunity to join Featherstone Farm’s efforts to harness these processes to further the farm’s goals of making a difference in the world is truly an honor.

Here's the original guest post on Featherstone Farm's blog.

I’m writing this from Little Rock, Arkansas, where I am doing a presentation on farm financials for the Southern Sustainable Agriculture Working Group.  It’s another in a string of presentations I signed up to do this winter, many of them with a focus on issues of scale in agriculture.

For beginning farmers especially, scale can cause significant problems as the business matures. Most of us get into this business to save the earth, get a feel for the soil, or simply to feed people – we don’t get into it to spend time crunching numbers at a computer, manage employees, or track down overdue payments.

Unfortunately – and I have a feeling that this happens to almost all small business owners – those are the very tasks that make or break a business, especially at the point when it needs to take a turn from being run on the constant over-exertions of the farmer and his or her dedicated crew.

So, one of the core messages I try to carry to beginning and expanding farmers is that they need to understand, at the outset, just how much they will eventually need to produce to sustain the quality of life they want to achieve; and since money is one sure way to unlock the flexibility and resources that can sustain an operation and a family, I focus on that.

If a market farming couple hopes to retain a $50,000 profit to cover their living expenses, mortgage, retirement savings, and such (this is a ridiculously low number based on the number of hours and level of risk assumed by most farmers, but I use it as an example because we tend to be a bunch with relatively low financial expectations), and market farms of their scale seem to average about a 40% margin, that means they’ll need to raise about $135,000 of vegetables – and that’s a lot more rutabagas than most of us got into farming thinking that we would be producing.