Buying Land: How will it impact your financials?

Read Time: 3 Minutes

cash flow projection sheet and glasses

From cash flow to risk bearing ability, there are several factors to consider when buying a piece of farmland. Let’s review the key calculations you will need to make to determine whether your operation is in a good financial position to purchase additional land. 


Evaluate Your Current Financial Situation

Whether you’re a first-time buyer or have purchased farmland before, the best starting point is putting together a current balance sheet that lists all your assets and liabilities. Do not include the new farm in this financial statement. Farm Credit Services of America provides a good overview of how to create and understand your balance sheet

Two important metrics that reflect financial health and risk bearing ability are working capital (current assets minus current liabilities) and owner’s equity (net worth divided by total assets). 

Working capital represents liquidity that is available for shortfalls in cash flow as a result of lower than anticipated production or price. The key is to maintain an optimal level of working capital equal to 20% or more of gross farm income. 

Owner’s equity can vary depending on enterprise and business model, but 65% or greater is generally considered adequate.


Complete a Cashflow Projection

A cash flow projection includes your expected income and expenses related to a single year of production. When preparing your projected income for the year, be as realistic as possible. Use multi-year average crop yields along with the current futures prices to estimate potential profit. 

When preparing your projected expenses, include the cost of seed, chemical and fertilizer and determine averages for fuel, repairs, insurance and other variable costs by reviewing your past 2-3 years of farm records or tax returns. You should also note changes in your operation from past averages and make any necessary adjustments. 

cash-flow-projection-example

 

Review our case study for more on how a land purchase will impact cash flow.

Know Your Fixed Costs

Your operation’s fixed costs include the costs that are incurred even if no output is produced. This would include your principal and interest payments and taxes on land, loans or leases for machinery and equipment and the cash rent paid on any rented land.

After you add up all your fixed costs, divide that total number by your share of acres farmed. When we talk about share of acres farmed, that means 100% of owned and cash rented farmland and 50% of acres farmed on a 50/50 crop share basis.

fixed-costs-calc

As an example, let’s say you own 100 acres, cash rent 400 acres and crop share another 300 acres. Your share of acres farmed would be 650 acres (100 acres owned + 400 acres cash rent + 150 acres shared = 650 acres).

The result of this calculation gives you the margin per acre that is needed to pay for your fixed assets after variable costs and family living costs are taken out of your annual gross proceeds.  

If your fixed costs exceed 40% of your gross farm income, your operation may struggle to cash flow without additional sources of income.

Factor in the Land Purchase

At this point you have your current balance sheet completed, a realistic cash flow projection prepared, and you know your fixed costs per acre. Now let’s factor in a land purchase by adding the new asset and the new debt to your balance sheet. Our affordability calculator is a good way to analyze if you can service the debt associated with the land purchase.

You can update your projected cash flow by adding the estimated income and expenses related to the new farm. If you plan to operate the farm yourself, you will need to add all variable costs such as fertilizer, chemical, seed, crop insurance, fuel, real estate taxes and potential added expenses for repairs and labor. 

The updated projection will also need to include the new principal and interest payments – our loan payment calculator can help you run scenarios. You can easily update your fixed cost analysis by adding the additional acres and new fixed costs. This will allow you to see the impact a land purchase has on the overall structure of your operation across all your acres. 

Considering land values today, it is common for net income to decrease (after principal and interest payments) as a result of a new land purchase unless you can provide a sizeable cash down payment. 

Therefore, it is important to verify that your operation has a consistent cash flow surplus each year from your existing land base to help support the cash flow of the new purchase until it can pay its own way. As you grow your operation, it is also necessary to increase your working capital to maintain your goal of 20% or more of gross farm income. 


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