Money

The Dangers of Schedule F

Be prepared to explain tax strategies on capital expenditures.

The other day, a producer told me he was extremely upset that he had been denied for credit for operating inputs for the upcoming year. The reason given by the lender was that he had not shown a profit or positive cash flow over the past four years. In this customer’s case, the standard balance sheet with three years of tax returns, including the Schedule F forms, was the information that was examined. The regulators that oversee the safety and soundness of the credit system are cracking down on credits that are showing losses on their income statements. Yes, banking regulators are carefully scrutinizing the agriculture industry, which is now in the fifth year of the agriculture economic reset. One area of focus in credit analysis is whether the business is profitable and cash flows.

In this producer’s case, like many others, the objective was to show losses through income and cost manipulations as a strategy to minimize taxes. The producer also utilized the Section 179 deduction, the ability to write off expenditures such as machinery and equipment in an accelerated time frame, which helped to minimize taxes. Using the information presented, regulators flagged the account with the logic that the business is not profitable. As more of the lending industry uses quick credit scores or analysis by credit teams looking extra carefully at financials, an increasing share of individuals requesting credit are going to be denied. If they are accepted, they will pay higher interest rates because of the additional risk involved.

Producers need to be aware of this outcome and appropriately prepare to build a case for their financing. The first step in building a case would be to do an accrual analysis. A prepaid feed or fertilizer expense may result in showing a loss on a cash basis on the Schedule F form, but a different and more favorable outcome may result on an accrual basis. Others may hold off revenue from crops or cattle in the form of inventory, which reduces cash profits and may actually show negative returns. However, if one does the accrual analysis, it could show a profit. Be prepared to explain tax strategies on capital expenditures. That is, what intermediate and long-term investments in buildings, equipment, and machinery have been expensed, which may distort the bottom line?

One may say that it is the lender’s role to do this analysis. Your lender can work side-by-side with you, but a producer must have an understanding of how their tax strategies are linked to the short and long run impacts on the business’ profitability and the ability to service debt. Credit is going to become tighter in agriculture for those that do not understand how to present their case as a result of tax strategies designed to show minimal income or losses. Please be aware!

TAGS: Lending
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