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Understanding and managing cash flow

  • 6 min read

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A cash flow budget is an estimate of all cash receipts and expenses expected to occur during a specific period. Cash flow examines money movement, not net income or profitability, but it’s an essential part of financial management.

Cash flow budgets and a cash flow statements are different. A budget is a projection of what’s going to happen. A statement shows what’s happened in the past.

Here are a couple of scenarios to illustrate why you need a cash flow budget.

Scenario 1: You’ve rented more cropland for the new growing season. You know your cost of production, and you’re confident the additional acres will enhance profitability and move your farm ahead financially. But, will you have cash available when rental payments are due? And, what about other farm input expenses that need to be paid before any crop is harvested? Is your current operating loan adequate?

Scenario 2: In the past, your cow-calf operation has sold calves during the fall calf run, but now you’d like to background most of the calves and sell them at a heavier weight in the spring. You have the feed available, and you believe this will enhance your profitability. But what will the income delay mean to your cash flow?

In both scenarios, a significant change in the business plan increases the need for proper cash flow analysis before making any final decisions. Cash flow planning is also needed on farms that may not be making significant changes.

Benefits of cash flow planning/analysis

  • Know when cash flow will be tight so you can plan for the shortfall
  • Identify the best loan term and repayment schedule
  • Make marketing decisions that are not under cash shortfall constraints
  • Analyze if interest rates rise or commodity prices drop (sensitivity analysis)
  • Help you decide to lease or buy a major piece of equipment

Different farms face different challenges. For example, on dairy and poultry operations, cash inflow typically is regular and predictable. For pork producers, sale volumes may be consistent, but prices could fluctuate dramatically. If you’re establishing a vineyard or orchard, it may be several years before you have any income and yet high costs are incurred during that time.

Many farms should calculate their cashflow monthly, while others can manage bi-monthly or quarterly. A cash flow budget is straight forward. It records your projected cash inflow and outflow for a specific period, along with the resulting cash balance. Typically, you’ll want to be projecting your cash flows a year or more in advance. 

Download a month-by-month cash flow sample from our Cash Flow Planning Guide.

Cash flow vs. profitability

If your cash flow is healthy and your business is profitable, it could be a good time to pay down debt or consider expansion.

A business can have significant cash flow shortfalls throughout the year and be profitable. Cash flow is not a measure of profitability. It excludes non-cash elements like depreciation but includes cash-reducing items like principle payments. These subtle but powerful differences make cash flow analysis a powerful tool for farm business managers. 

Off-farm sources of income (like salaries or from other business ventures) can also contribute to cash flow. You can consider this income in your cash flow analysis, but it doesn’t count towards the farm’s profitability. But, if you schedule withdrawals from the farm to pay living expenses, it should be part of the analysis.

Review and update regularly

It’s helpful to compare your cash flow budget against your cash flow statement and note any changes. Update your cash flow budget as new information becomes available. It’s only as accurate as the assumptions used to prepare it. Cash flow items like loan repayments and utility bills are usually predictable. There may be slight variations, but you know how much will be paid and when.

But the timing and amount of other cashflow elements can vary greatly per year. A large, unexpected equipment repair bill or an additional pesticide application can materialize at an inopportune time. Feed prices can rise due to supply shortages.

Opportunities don’t always have the best timing either, A piece of land you’ve always wanted might become available, and you now require a cash down payment. Feed could be readily available and cheap, but can you afford to background your calf crop this year? Or you have a bumper crop, but not enough bin capacity and you wonder if you can you afford a new lease payment?

Despite the unknowns and uncertainties, cash flow planning is the only way to anticipate shortfalls and take appropriate action in advance.

Operating loans

It’s common for farms to use operating loans or lines of credit to bridge the expected gaps in cash flow. The federal government also supports a low-interest cash advance program for livestock and crops with the first $100,000 interest-free.

Sometimes crop input loans or delayed payment options are available from vendors. These might be viable options if the input costs and interest payable is competitive. However, you don’t want options that cost more than necessary. A cash flow budget provides the most accurate estimate of what the cash shortfall may be and what actions are most appropriate.

Again, cash flow analysis is not a measurement of profitability. However, if your operating loan balance has continued to increase or you’ve struggled to revolve it, while your overall farm size isn’t growing, it could be a sign of profitability issues.

Operating loans should only be used to cover operating expenses (the costs needed to produce a product like grain, market livestock, milk, etc.). Purchasing capital assets with operating loan funds can cause financial trouble. The cash needed to run the business is tied up paying for an asset that will “pay for itself” over multiple operating cycles.

Therefore, capital assets should be financed longer-term. To manage this, some producers develop a multiple-year plan to consider their farm’s equipment replacement requirements - typically for the next five years. Often referred to as a capital budget, this plan is flexible as situations change, but these projections can dovetail into your cash flow planning.

Marketing and purchasing considerations

Dairy, poultry and hog operations typically market their production regularly. Cow-calf producers and cash crop farmers have more flexibility and may try to time their sales to coincide with better pricing opportunities. Sometimes crops are stored for many months or even years. This practice of holding inventory can potentially increase your returns. However, consider all the costs involved in grain storage.

But holding commodities off the market is only feasible if it fits within a cash flow plan. The flip side is being forced to market your product no matter the price because you’re in a cash flow crunch. Cash flow planning can help you avoid this situation.

If you’re a grain farmer and your cash flow analysis shows you need to sell soon after harvest to meet expense commitments, you can decide in advance about what to sell and whether to forward contract. If you don’t plan and discover you need to sell within a short time, you’re marketing options may be less attractive.

As the old axiom states, cash is king. That’s why cash flow planning is such an integral part of farm financial planning. A cash flow statement records your history. A cash flow budget projects for the future. And here are some actions you can take now: :