Fourth Quarter Financial Success
Prepaying inputs and deferring income seemed like a foreign concept for the last several years on U.S. dairy farms. Meeting with your farm's accountant before Thanksgiving wasn’t an absolute. But the tides have changed in 2022, as a different story has unfolded. Reviewing profit and loss statements this year has been a welcoming sight, highlighting profits earned on most U.S. dairies.
Despite inflation impacting every corner of dairy operations, including that skyrocketing feed bill, milk prices have been strong and have helped generate positive cash flow for the year. Unlike previous years, 2022 has illustrated healthy checkbook balances that positively reflect that money is available to pay most operating bills. Leading dairy financial experts strongly encourage producers to push pause sooner rather than later to outline the steps needed to take place in Q4 to wrap up the year on the best foot possible and help position a dairy for a successful start in 2023.
Jim Moriarty, director of dairy at Compeer Financial, says while we are still in the midst of harvest and field work, it is not too early to begin the year-end planning process.
“There are a number of reasons that should cause us to get started on our planning sooner versus later this year,” he says.
Independent dairy financial consultant Gary Sipiorski concurs with Moriarty and strongly encourages producers to schedule a year-end tax meeting with an accountant early. Sipiorski says producers must conduct a preliminary year-end balance sheet to get an idea of what their assets and liabilities look like. He also advises that producers need to put together a preliminary year-end incomes statement for their account. According to Sipiorski real profit should be measured with an accrual-adjusted income statement.
“I am sure I sound like a broken record on this topic,” he says. “However, in a year like this one or any year, ‘true’ profitability should be measured.”
While in past years, producers could afford to wait until mid-December to meet with their accountant, both financial experts say that year-end tax meeting with an accountant needs to begin early. Sipiorski says that while balance sheets are helpful for accountants to give their best analysis, reliable year-end income and expense estimates are necessary.
“Remember though, taxes do not reflect true profitability. However, producers need to take advantage of tax opportunities for prepaying expenses and depreciation allowances,” Sipiorski says. “They need to have a discussion with the accountant and ask questions. Make sure that the long-term ramification of any depreciation plan is fully discussed. It is the owner’s responsibility to make the final decisions.”
Power of Prepay
According to Sipiorski, a good way for producers to best position themselves for 2023 is to not only have the accountant meeting before 2022 ends, but also suggests prepaying some of 2023 expenses based on your accountants recommendations.
“I’d also suggest considering milk marketing when prices reflect a margin,” he says. “Once again this is totally up to the owner to make these kinds of decisions.”
Sipiorski also advises that every producer sit down and perform a 2023 projection.
“Use 2022 as an expense guide and consider where the future milk markets are with advice from knowledgeable universities or brokers to use as a milk price,” he says.
Furthermore, a lender meeting for additions to a Line of Credit (LOC) or a new LOC may be needed to fill in some months when cash is short.
Year-End Action Steps
Moriarty shares that there are several reasons that producers should get started on their financial planning soon. He provides four action steps that producers should consider.
Tax Planning. With high milk prices this year, most farms are seeing solid profitability and cash flow. As we look ahead to next year, margins may be much tighter as milk prices soften and feed and other costs stay high. Proper planning with your tax advisor can enable smoothing out taxable income between years by prepaying expenses and deferring income. It will be important to evaluate potential taxable income and start to implement strategies by early November to make sure you can use income deferral as well as prepays as part of your strategies to balance taxable income between years.
Risk Management. We are currently in a situation where both milk prices, feed and other costs are at an elevated level. Futures prices are still indicating the potential for profitable margins for 2023, but the situation is tenuous with milk prices trending down due to slowing economic growth and feed prices increasing due to lower crop yields. This is a time to be protecting at least some of the profit potential by managing milk, feed and input costs. It can be difficult to pick the right price points, so we are encouraging producers to start by getting 20-30% of milk, feed and inputs priced and then layer in more coverage from there. Not doing anything can be the decision with the highest risk right now.
Plan and Prioritize Capital Investments. It can be tempting to make larger equipment purchases before year-end to help reduce tax liability. Before we make major purchases, we want to step back and plan out facility upgrade needs, growth plans, potential land purchases and equipment replacement over the next several years and make sure we save financial capacity for those investments that can generate the highest return and mean the most to our business. Preparing a 3-to-5-year capital plan can really help us think through those priorities and avoid quick decisions that can limit our future options.
Preserve Working Capital. Farmers have been able to build working capital by catching up on payables and reducing balances on lines of credit with the cash flow from high milk prices this year. With interest rates increasing sharply this summer, it may seem logical to use cash and short-term lines to make capital purchases rather than using term loans at higher rates. As we look to volatility ahead, continuing to utilize term loans for at least part of your capital purchases is advisable to keep working capital available for a potential downturn.
“We know it can be difficult to think about year-end planning while you are working long days through harvest, but taking a few minutes now to schedule time with your tax advisor, risk management consultant, agronomist and lender early will pay dividends in being prepared for year-end and the new year,” Moriarty says.
Making time to take these financial steps today will help you decide what path to take in 2023. Waiting until the last minute will likely result in frustration and trying to play catch-up around the Christmas holiday. Avoid that by acting now and set your business up for success in the New Year.
By KAREN BOHNERT
November 10, 2022