Ahh, that blissful feeling of finishing your year-end financials.
You’ve totaled the bank balances.
Listed your income and expenses.
Painstakingly answered the 101 questions from your accountant.
And even though you’re breathing a sigh of relief because you’re finished for the year…
…You’re also probably wondering if you could have:
- Saved more tax
- Reduced your expenses
- Made more money
If you’re like most farmers, the answers are most likely (unfortunately): yes, yes, and YES.
The truth is, there are a few common finance mistakes that cost farmers a heap of money every year at tax time. 4 of them, actually.
But there’s good news…
These 4 mistakes are really simple to fix, once you know what they are.
You don’t need to be a finance expert to understand the solutions.
And they’re easy…many can be solved in less than an hour. (One of them actually takes no time at all to do.)
So that next year, you’ll submit your taxes feeling completely confident that you’ve made and kept as much money as you possibly could.
Keep reading to learn the 4 year-end financial mistakes most farm owners make — and what to do instead…
Mistake #1: Buy a heap of stuff at the end of the year (because the tax man told you to)
This is probably the most common year-end tax mistake…and almost all farm owners tell us they’ve done it.
At the end of the year, many accountants suggest buying an expensive piece of machinery to reduce your profits on paper and save some tax.
You probably have a wish list of things you want on the farm, right? So this is a no-brainer. You buy a new harvester or a shed or a brand new ute (or maybe all 3) and think you’re making a good financial decision.
The problem is, this ends up COSTING you money, not saving it.
Sure, it might save you a bit of tax this year. But in the long run, it’s like spending $1 to make $0.30.
Let’s say you bought your current harvester 8 years ago and it cost $200,000. It still works great and your plan is to sell it in 2 years, after 10 years of use.
But then your accountant tells you to buy something to save some tax. And there’s a good trade-in deal for your harvester this year. So you figure you may as well trade it in and get a new one.
But there’s a big hidden cost…
You just cut 2 years off the use of your harvester! So instead of paying $200,000 for 10 years of use (essentially a cost of $20,000 per year), you paid $200,000 and only got 8 years of use out of it ($25,000 per year).
You effectively just cost yourself $50,000 by replacing it 2 years before you needed to. (And it definitely didn’t save you $50,000 in tax.)
See? In the long run, this strategy can cost you a whole lot more than it saves.
Profitable farmer solution:
This one’s simple: Only buy new equipment when you truly need it.
Bringing forward expenses can be a good way to assist with tax planning but it must be done with careful consideration of the follow-on effects to the profitability of the business.
The most profitable farmers have a well-documented plan for equipment replacement — and they only deviate from that plan where there is a clear financial advantage to bringing forward investment in that equipment.
Remember: the more profitable your business, the more tax you pay. Be careful about focusing on short-term tax minimisation at the expense of long-term business profitability.
It’s often better to make more profit in the long run and pay a little more tax today than make expensive purchases before you need to.
Mistake #2: Accept your current rates
What’s one of the best ways to increase your profits?
Reduce your costs.
And one of the easiest and fastest ways to reduce your costs next year is by reducing your interest rates from your bank, fees from your selling agents, etc.
Most farm owners accept the interest rates given to them as gospel rather than seeking to reduce them.
But the truth is, your lender can almost always offer you a better rate…if you’re willing to ask for it.
Lenders want to make as much money off their loans as possible. So it’s in their interest to give you the highest rate that you’ll accept.
Read that again: Your lenders are currently offering you the highest rate they think you’ll accept.
What does that mean for you? There’s nearly always room to negotiate your rate down. Lenders would rather make slightly less off your loan than lose you entirely.
But lenders won’t just give you a lower rate. You need to ASK for it.
Profitable farmer solution:
Have conversations with each of your lenders to see if they can offer you better terms. Explain your need as a business owner to reduce your costs and ask them what they can do to improve your rates to keep you as a customer.
Here’s a tip if you want to negotiate your bank rates…
Speak to a lending broker who’s independent of your bank. They’ll share all the deals available in your position so you know what else is out there. (It’s often better than the terms you’re currently getting from your bank.)
Then, present those better offers to your bank manager…and ask if they can match them.
It doesn’t cost you anything to shop around and negotiate. But it could save you a whole heap of money next year at tax time.
Mistake #3: Store your money in FMDs
Many farmers put loads of money into FMDs (Farm Management Deposits)…and it’s one of the biggest mistakes you can make.
An FMD is a holding account where you can store your income and defer paying tax on it to a future date.
And FMDs can be useful…
Especially if you farm in a risky area where your income is quite variable. In the good years, you can essentially store money in your FMD and then dip into that pot to get you through future, poorer years.
…But you always end up paying the original amount of tax eventually. It’s just spread out over years instead of all at once.
Using FMDs isn’t a tax minimisation strategy…it’s a tax delay strategy. You’ll save some money today but create a future tax obligation for yourself.
And here’s why it’s such a costly mistake (if you’re not in a high-risk area or you have your account maxed out for extended periods):
The money in an FMD hardly earns any interest (often less than inflation). It just sits there, like keeping a pile of cash under your bed.
…When that same money — if used differently — could be working for you and making you even more money.
Profitable farmer solution:
Unless you live in a high-risk area, you’re often better off paying the tax now and investing the remaining profits to grow your wealth.
There are so many ways to make your money work for you rather than have it sit in an FMD doing nothing.
- You could invest it in the share market
- You could buy the farm next door or an investment property
- You could scale your business by hiring help or working with a coach (Farm Owners Academy can help you there!)
Those are all much smarter uses of your money because you’ll make it work for you, instead of sitting there earning minimal interest in a FMD.
Let’s look at an example:
Say your average tax rate is 30%.
If you have an average of $500,000 sitting in FMDs for 5 years earning you 0.45% interest, it’ll be worth $507,925 in 5 years time. At that stage you withdraw the money and pay $150,000 in income tax. This leaves you with $357,925 after tax in 5 years.
But if you took that same $500,000, paid the $150,000 tax immediately, leaving you with $350,000 and put it into an investment that earned you 8% compound return over the next 5 years (say, the share market) it would be worth $489,625 in 5 years!!
That’s an extra $131,700 for doing absolutely nothing!
The table below lets you see how the numbers play out…
Mistake #4: Make financial decisions by your bank balance
Most farm owners make financial decisions by asking, “Do I have enough money in my bank account? If yes, I’ll buy this. If no, I won’t.”
But that’s the wrong way to manage your business choices.
Because when you make decisions by your bank balance alone, you miss the big picture.
It’s much smarter to base your financial decisions off of a cash flow forecast.
A cash flow forecast is an estimate of your income and expenses each month, based on where you want to end the year.
Think of it like a household budget for your business…
Imagine you’re saving for a holiday in June that costs about $5,000. In February, you get two speeding tickets that cost you $2,000, thanks to your lead foot.
Does that mean you can’t take your holiday? Not if you adjust your decisions!
If you know where you’re at relative to your budget, you can make some changes over the next few months to cut back and still afford your holiday. You certainly wouldn’t buy a new TV just because you see $1,000 sitting in your bank account, right? Because that money is earmarked for your holiday.
That’s why having a 12-month cash flow budget is so important.
Knowing your baseline of what to expect each month allows you to change your plan depending on what happens as you go. It’s a much smarter tool to make financial decisions from than your bank balance.
Profitable farmer solution:
Create a 12-month cash flow budget with predicted monthly revenue and expenses.
The most profitable farmers then benchmark their budget, allowing them to know exactly what financial result they will achieve if they follow the plan.
You want to create a cash flow budget that helps you maximise profit, given the circumstances that may play out. It’s not just about minimising costs!
We recommend that all farm owners develop a production model for their business, based on their assumptions re: predicted production outcome, costs, and income for the year.
Then stress test that with different price and season assumptions and prepare a monthly cash flow budget from your most likely outcome for next season.
Knowing what you will do differently in a top 20% season to maximise profit — and in a bottom 20% season to minimise the downside — are also keys to effective cash flow budgeting.
To help you get started, we’ve got a template to create your 5-year cash flow forecast. Just click here to download your free cash flow forecast template.
RELATED POST: The 3 key financial figures profitable farmers track
And there you have it: the 4 year-end financial mistakes most farmers make:
- Making big purchases at year-end to “save tax”
- Not negotiating with their lenders for better rates
- Dumping a heap of money into FMDs
- Not using a cash flow forecast to make financial decisions
Each of those four areas will enhance your profits in a unique way. If you focus on making those four changes this year — or even just one, honestly! — you’ll feel confident next June that you made smart financial decisions and made (and kept) as much money as possible.