What The User Sees – You In Their Shoes
By Gerard Fitzpatrick, FCA, TEP
Country Guide
February 2008
The expression goes that you must walk a mile in someone else’s shoes to truly understand what they are thinking or feeling. Should the rules be any different when attempting to understand how your creditors view your financial statements? In order to better understand what the credit specialists look for in your financial statements, put yourself in their shoes by asking the questions that they would ask.
We already know that every banker looks at statistics or financial ratios to determine how your farm stacks up against other operators in the industry. These statistics are also compared against figures that the banker feels are realistic for the industry, independent of what other operators are reporting.
To improve your understanding of how a banker evaluates your financial statements, it is beneficial to define some of creditors most frequently-used terms:
- Equity – the percentage of your assets that you own
- Liquidity or current ratio – the ability of your farm to meet short-term obligations on your balance sheet with the current assets on your balance sheet
- Return on assets – the ratio of net income + interest - drawings to assets
- Repayment capacity – Net income + interest + depreciation/amortization - drawings as a percentage of annual interest + principle repayments
- Funded debt – debt that has interest attached to it; this would not normally include trade debt or non-interest bearing shareholder loans or capital accounts
- EBITA - earnings before interest, tax and depreciation/amortization
- Draws – money, exclusive of wages, removed from the farm for personal use
- Working capital – current assets on your balance sheet less current debt on the balance sheet
Schedule A describes some of these ratios and the associated concerns that bankers might have if they are not favorable. If a banker has worries about some of the figures on your financial statements, you may have reason for concern as well.
In addition to ratio analysis, some creditors will also break down the financial statements on a per hectoliter, per kg, or per acre basis in order to further measure financial performance of your dairy farm or cropping operation. Some financial institutions, however, are moving away from the “per” analysis and rely solely on ratio analysis in addition to several other measuring sticks.
Cash flow is king for most financial institutions when evaluating financial statements. The institutions are working toward benchmarking your operation against other clients with similar operations or against the industry standards. Some institutions are also using different measurement tools such as operating expense ratios or working capital as a percentage of the cash costs of the operation.
Above all, however, financial personal are impressed with clients who can identify problems as – or before – they occur, and communicate the situation to their banker as soon as possible. In tough times, most bankers will look at historical performance and track record of the farmer as a manager. A history of good communication between the farmer manager and the bank will definitely benefit the client when trying to work through a rough patch.
Bankers do not have time to put the puzzle pieces together at the year end, so ensure you provide them with accrual basis financial statements, not cash basis. It is also beneficial to present a current list of fixed assets and their values. Remember, if the banker is provided with current and timely information and has an ongoing open relationship with you, it is much easier for them to work with you in good times and bad. This may sound like a marriage, and in many ways it is. Similar to the breakdown of a marital relationship, a divorce from your banker can also be costly and unpleasant.
I wish to leave you with this quote on learning:
"Education is learning what you didn't even know you didn't know." - Daniel Boorstin
