This article was featured in the February 13th
, 2018 print edition of Grainews
A cash flow projection is a versatile financial risk management tool
This article originally appeared in the February 13, 2018 edition of Grainews
Preparing a cash flow projection as part of your annual farm budget process could provide a signal that changes are needed for the upcoming year. While its true farmers have no control over the weather or commodity markets, we do have control over most costs. With the exception of unpredictable pesticide decisions, annual expenses may be accurately estimated prior to seeding.
A cash flow projection is essentially your farm financial forecast expressed as cash receipts net of cash payments over a defined period of time – usually monthly or annually. The projection can provide numerous farm management benefits in addition to forecasting cash shortfalls or surpluses.
The cash flow projection should be developed as part of an annual farm budget. Your local crop input supplier likely prepares an annual budget yet faces similar uncertainty related to the weather, commodity prices, and ultimately sales. A budget is used to predict and manage cash flow and costs such as inputs and labour. Actual results can be compared to the budget and used in decision making.
Capital Budgeting and Financing
A cash flow projection can aid in a land or equipment purchasing decisions. The effect of adding additional land through rent, crop-share, or purchasing can be effectively estimated using average, worst-case or best-case crop scenarios. For longer term planning, a capital budget can be developed as part of your cash flow projection to guide decisions about how much cash should be set aside annually for reinvestment in land or equipment.
If you have recently applied for a land or equipment loan, your bank may have prepared a cash flow projection to support your loan application. You should ensure this projection is not missing information as this could be detrimental to your credit rating. Consider whether you leased additional land, reduced your equipment costs, or recently paid off high interest loans. Preparing your own cash flow projection could provide you with additional leverage when negotiating your next bank loan.
Preparing a monthly cash flow projection can identify the months of anticipated cash shortfall. Grain sales can then be targeted in these months to avoid high bank interest overdraft or line of credit charges. Forecasting shortfalls ahead of time will give you time to formulate a grain marketing strategy and avoid forced grain sales due to an unforeseen cash shortfall.
A cash flow projection will not improve grain transportation issues or make it rain, however, having financing in place when grain is not moving, or when it does not rain, will be necessary to protect your business. An updated or rolling cash flow projection is a valuable decision making tool when unexpected events happen such as crop failure or buyers not taking grain when contracted.
Preparing a cash flow projection will provide an estimate of the cash available to be drawn from the business for personal use. This information can then be used for personal financial budgeting. Or in cases of cash shortfalls, the cash flow projection can provide an estimate of off-farm income needed to invest into the farm operation to fund expansion or operating deficiencies.
Farm Succession and Transition
Projecting cash flows can provide benefits for both parties during farm succession and transition. The acquiring party may be in an expansion phase and need to incur significant debt. The cash flow projection can predict whether enough cash is available to operate the farm and fund the cost of living. On the other hand, the exiting party may require forecasting to predict retirement income needs. For example, some farm land may need to be sold in order to meet retirement cash flow goals. The cash flow requirements of both parties would typically be a significant consideration in any farm succession and transition plan.
If a crop share arrangement is being considered as part of your farm transition plan, a cash flow projection would be an effective tool to compare this option against a cash rental arrangement.
Your cash flow projection should be updated annually. Considerations such as crop mix, commodity prices, and machinery costs change periodically and as a consequence so too will your cash flow projection. A rolling twelve month projection is ideal but may not be feasible for most farm operations.
If cash flow is not a primary concern, a projection can still be useful to determine how best to put your money to work. If cash is not required to fund the next operating cycle, other investing options should be considered.
Consult your professional advisor to learn more about this important financial risk management tool.
Questions? Contact Craig Macfie
, a Manager with Stark & Marsh CPA LLP specializing in Agriculture.