45 Year Old Retirement Avoided

SW Financial Literacy

45 Year Old Retirement Avoided

A few weeks ago, I wrote an article called “45 Year Old Retirement”. That piece explained some of the transactions, decision making, and financial path that this producer took over the past five years to end up in today's position.

I had a follower of the newsletter reach out to me, saying that they enjoyed the article but wondered what could have been done to avoid the retirement outcome. That's exactly what I'm going to try to do today. Here is a link to the original article: 45 Year Old Retirements.

P.S. Please remember this is a completely hypothetical scenario now. Any differences in decision making by the farmer in the first article compared to this one are underlined to help you better track the mindset shift that has occurred. There are 100's of things that could have changed, but I tried to keep the changes only to what is outlined below. Assume yield, commodity prices and marketing, and input expenses (and even repairs) were identical for both farmers.

Enjoy!

The Balance Sheet

Here is our “story’s” balance sheet as of year-end 2021 and 2022.

In 2021 the operation was sitting in a fine position. Working capital at $284/acre with a current ratio of 1.55:1. Both of these would get you approved for financing and are a decent spot to be in after the tough 2015-2019 years. The operation has a net worth of $3.7M and Equity/Asset % of 74.06%. All these things are good! They have just $1.3M in total debt and are comfortable.

Record 2022 profits come storming in. Look where the operation skyrockets to! Working capital is up to a whopping $635/a and a total of $762,000 against just $1,092,000 in total debt. Another year like 2022 and the operation can pay off all debt and coast with their farming career to the finish line. Total equity is up to $4.2M with EA% at 79.55%, which rivals established operators of 40+ years.

This is exactly where our previous story started, and this is where we now divert with some decision making.

The landlord just offered to sell you 120 acres. You snatch this up but choose to finance the entire purchase over 30 years (compared to 20 years) to preserve cash. 8% interest rates are unfathomable after seeing 4% or lower in 2020, but you know you can move that fix rate lower in the future and can’t always get the cash back.

Something weird happened right before the end of 2022 and through 2023. MAJOR TAX PROBLEM. You must spend money fast or you will have a $300k income tax bill and your private health insurance rate will go through the roof. You have one of the best ag CPA’s (because you asked around and moved to them a few years ago) in the state who makes you aware of the Section 180 tax deduction. You prepay all 2023 expenses at year-end 2022, then can deduct your land purchase in 2023.

There was also the plan of making a few farm upgrades. It is decided the tractor and skid steer are the most vital pieces to replace. They are financed as well, with the tractor being put on a lease due to lower annual payments and the tax advantages in future years.

Where does this leave us compared to the original scenario?

By financing 100% of the land purchase:

Land payments are $50,000/yr HIGHER and Working Capital is $490,000 HIGHER than the original.

Since we didn’t upgrade the combine or the shed, TOTAL debt payments per year overall are $72k LESS THAN the original.

Here is the updated trend for year-end 2023:

Let’s review

We lost $232,200 of Working Capital due to lower commodity prices and some extra debt payments to make with the land purchase, tractor lease, and skid loader. This compares to a $757,200 in Working Capital loss in the original scenario which left them with a Working Capital of just $4,800 and Current Ratio of 1.01:1 going into 2024!!!

I want to highlight again the decisions that were made in 2023 to make Working Capital $525,000 higher just 1 year later, with the exact same yields and marketing decisions:

1. Land purchase was 100% financed, instead of a $500,000 downpayment which was made in the original due to higher interest rates.

2. 30 year land loan instead of 20 years, to also preserve working capital but also help Cash Flow (which is highly beneficial in 2024-2025).

3. Good CPA was able to solve the tax problem without huge equipment purchases thanks to leasing structure, prepays, and Section 180 through the land purchase.

4. Building was not upgraded.

5. Combine was not upgraded.

2024

In 2024 we start to see the large inflation of inputs. The operation doesn’t make a single equipment purchase in 2024, but higher input prices combined with swelling debt payments put on in 2022-2023 makes the operation lose $183 Working Capital/acre (compared to $229 in the original). This doesn’t look good, but a $100,000 capital injection loan is not needed because they still have Working Capital per acre at $259 and a Current Ratio of 1.68:1, both of which are above lending standards.

Note here that we are starting to see the payoff of their 2022-2023 decisions having a trickle down effect:

1. Cash flow is better than the original because there is less debt to service, even though they borrowed more on the land purchase.

2. The operating note and credit card balances are significantly lower, which is saving in interest.

3. The cash account and Stocks were not used as the down payment for the land purchase, so they are still intact as an emergency fund.

4. Because of #2 & #3, a capital injection note was not needed.

5. The original started to sink faster because of the capital injection note, which made cash flow even worse.

The dominos are falling in the original scenario…

2025

2025 is here, and this is what happened. Personal vehicles we not updated because the farmer was concerned by the 2024 losses. And that’s it! Inputs are still higher, yields are down, prices are down.

The operation lost another $122 Working Capital/acre (compared to a 2025 loss of $275/a in the original). 2024 and 2025 have been hard times for row crop producers, and this updated balance sheet has taken a big hit. They went from a high of $762,000 Working Capital in 2022 to just $163,700 today. But do you remember where the original ended up?

That is a $765,600 difference in Working Capital between the two.

What made the difference?

There are 3 main takeaways I want you to learn from this exercise:

1. Cash is King.

   1. Yes, looking in the rearview mirror gives us 20/20 vision. No, it isn’t fun putting purchases on an 8% interest rate. There was a lot of equity in ground to allow for higher amounts of financing on land purchases to preserve cash positions. We were seeing inflation occurring because of COVID and supply chain issues and forgot how much cash it took to combat inflation in 2013-20215 which also burned a ton of cash. Most of the 2022 cash earned needed to be buried in the backyard for a rainy day.

2. Slow down decision making.

   1. The wise thing to do in 2022 was to slow the decision making down. Don’t make 3 years of purchases in 1 year, just make 1 year of purchases in 1 year. Time is on your side when you do this. If you have a profitable 2023, great! Then make 1 year worth of purchases again. If 2023 is rough, then reevaluate your plan. Don’t go off course and spend all your birthday money in the first week. You might not get birthday money again for a few years.

3. Purchases have consequences.

   1. This new scenario saw the farmer financing MORE of the land purchase, which made the Cash Flow WORSE in year 1. Because of the tighter cash flow, they didn’t feel they had sufficient room to make the building and combine upgrade to the operation. Fast forward a few years, and the situation has flipped, at least concerning cash flow. This article has $100,000/year less in debt payments to make compared to the retiring farmer (over $100,000/year in better Cash Flow) AND they have $765,600 more Working Capital.

These were identical operations in 2022. Within 3 years, they are unrecognizable from each other. This is why I coach financial literacy and the importance of understanding your position and goals before making any purchase. One wrong move can head you down a path of no return.

Original Scenario

New Scenario

Do you have an upcoming land purchase?

I have limited spots available for 1-hour consultations helping you:

• Understand your farm's financial position.

• Prepare for future growth opportunities.

• Discuss purchase & finance options on farm transactions you are working through now.

Sign-up here if my services can benefit your operation:

https://calendly.com/grant-farm640/60min

Make it a great day.

Grant