In last week's post, I talked about how it's impossible to be prepared for every unexpected change that could affect your business. But it's good to be proactive about some of those factors by setting up a stress test for your business in the areas that could be most likely to affect your operation. We looked at interest rates as an example of that.
Another issue that could greatly affect your operation are land values. This one depends a lot on how you're valuing your land on your balance sheet. If you're currently valuing your land at fair market value, then if land prices drop and your equity isn't very high, your banker might suddenly want to talk to you.
However, if your land is valued at your purchase price on your balance sheet, then you could probably take a hit in land fair market values without seeing problems for your operation.
How is your land valued?
On your balance sheet, some banks will just want to see what the farmer paid for the ground, and aren't concerned about the fair market value. Others want to know both factors: What did you pay, and what's the fair market value? They may even want to see two different versions of your balance sheet.
There can be some value to you, in terms of knowing where you're really at, by not increasing the value of owned land on your balance sheet, even if land values are rising. Your balance sheet won't show an increase based purely on land values going up, since that wasn't of your own doing.
An increase like that can actually be very misleading to you as the farm owner, because it could appear that your operation is doing well when in fact it may actually be struggling. So by not increasing the values, you're able to see what the actual earned net worth of your business is.
Stress test the right areas
Find out how your banker wants you to value your land on your balance sheet. You might also create another version of your balance sheet – for your own benefit – that shows your land valued in the way other than what the banker is asking for. Stress test the fair market value balance sheet as if there were to be a drop in land prices – a small drop, and a bigger one. See how it would affect your farm.
Remember there are other types of risks that can benefit from stress testing in your operation that won't show up in financial scenarios like these. That might be whether or not you have enough liability insurance to cover your operation, if one of your employees were to get seriously injured.
Or maybe you have five siblings – and you're the only farming child. Nothing has been done by your parents with regard to their estate. Are you going to take the chance that you won't be farming anymore when your parents pass away? Or do you have the opportunity to proactively have a discussion about that with them?
Doing a stress test can show you where potential issues lie – before they become actual problems. In what areas do you need to stress test your farm business?
The opinions of Darren Frye are not necessarily those of Farm Futures or the Penton Farm Progress Group.