For some farmers, managing cash flow means paying bills until the checking account is empty, running credit cards up to their limits, then hoping the mail carrier delivers a check or two instead of just bringing more bills.
If handling your farm’s cash flow by the seat of your pants is stressing you out, cash flow planning and analysis will help to ease your anxiety.
Cash flow projection
Cash flow planning starts with a month-by-month projection of the cash flow you expect to see in the year ahead. The projection can begin on Jan. 1 and follow the calendar year; or it can start when something big is expected to happen that will significantly impact the farm’s cash flow — such as a land purchase, construction of a new building, or taking on new debt payments.
A cash flow projection is a prediction of all the cash which is likely to flow into and out of the farm operation during a given period of time. On the cash inflow side, it includes money generated from the sale of farm products, government program payments, machinery and breeding livestock sales, income from off-farm employment, and proceeds from new loans. Cash outflow includes operating expenses, principal and interest payments on loans, funds used for capital purchases, income tax and Social Security payments, and family living draws taken by the farm owner.
An annual cash flow projection is a very useful tool for a farm. Plot out, on a month-by-month basis, when cash income will be received and when cash expenses will need to be paid. The projection will help you anticipate in which months cash inflow will not meet your needs. Most importantly, you will be able to plan ahead to cover the cash shortfalls without tapping credit cards or leaving unpaid bills, and possibly wrecking your credit score.
Solutions for negative cash flow months
Nearly every farm will have months — possibly even years — when cash flow from farm operations is negative. Summer is often a time of year when farm cash flow is poor. The bills for seed and other crop inputs have been paid, there might be bills for machinery repairs, and there isn’t much to sell until later in the year.
If you develop a cash flow projection and figure out that cash flow is going to be short in some months, you have several options to cover the shortage. Maybe you can build up your cash reserves during good months. Perhaps you could add another farm enterprise which brings in cash flow during months you would otherwise fall short. You may be able to pick up some off-farm work at slower times of the year. Consider negotiating to re-schedule payments of some bills or term loan payments to better match your cash flow. Additionally, you could set up a line of credit with a lending institution, which can be tapped in lean months and paid off in good months.
If you need to use short-term credit to bridge your low cash months, work with a reputable lender and apply for a farm operating loan or line of credit. The terms will be much better than paying exorbitant credit card interest rates.
It’s awfully tempting to get through a few months of tight cash flow by using the handiest source of short-term credit: credit cards. Please don’t use credit cards to cover cash shortages — even if you typically pay them to zero every month. You could unwittingly exceed the acceptable credit utilization ratio (usually 30 percent of the limit on the card), which will damage your credit score. You could also find yourself unable to pay the entire balance in a cash-short month, and you’ll rack up interest at an 18 percent or higher annual rate.
Over the long run, the farm operation should generate enough positive cash flow from operations to pay all of its operating expenses, make loan payments, pay the farm owner a decent draw, and have enough cash left to replace some capital equipment and put a bit into cash reserves.
If the operation consistently runs negative cash flows, you should undertake a more in-depth financial analysis and consider making structural changes to your farm business. This sort of analysis is done at the end of the year, and looks back at the farm’s actual cash inflows and outflows.
Analyzing cash flow
To analyze cash flow, we break it out into three distinct categories: cash flow from operations; cash flow from investing activities; and cash flow from financing activities.
Breaking out the farm’s cash flow will tell you if the farm operation paid its own way or was subsidized by other sources of cash such as off-farm income, proceeds from new loans, or with sales of capital assets such as equipment or breeding livestock.
Cash flow from operations includes all of the dollars that flow in and out of the farm in normal, day-to-day activities. Cash comes in from sales of milk, fed cattle, grain, vegetables and other products. Cash might also come in from government payments and custom work. Cash flows out as you pay for seed, feed, fertilizer, fuel and other operating expenses. We want cash flow from operations to be positive every year.
Cash flow from investing activities refers to capital investments in the farm, not the dividends you received from investments in mutual funds. Cash inflow in this category generally comes from sales of machinery, breeding livestock or land. Cash flows out to pay for purchases of these capital investments.
Cash flow from investing activities — whether positive or negative — can offer clues to other aspects of farm management. For some farms, cash flow from investing activities might be positive because the farm does a great job with heifer calves and always has excess breeding stock to sell. For others, it might be positive because machinery is being sold to cover shortfalls in cash flow from operation and nothing new is being purchased. Cash flow from investing activities might be negative because the farm is using positive cash flow from operations to make capital improvements, which is good.
Cash flow from financing activities considers funds provided by lenders as well as funds made available by the farm owner. Cash inflow comes from new loans and from off-farm income. Off-farm income is included because it’s money which could be tapped by the farm if needed. Cash flows out to make principal and interest payments on loans and to provide for cash withdrawals by the farm owner.
It’s helpful to look for patterns in cash flow from financing activities. Are loan payments being made on time? Are principal balances being paid down faster than new loans are being taken out? If the farm has an operating loan, is the balance being paid down or is only the interest being paid? Is the owner able to take a regular cash draw out of the farm, or is he or she putting more money into the farm?
The farm operation should generate enough positive cash flow from operations to pay all of its operating expenses and have enough cash left to replace some capital equipment, make loan payments, and pay the farm owner something back for his or her investment in the farm. If cash flow is coming up short, a more detailed cash flow analysis is in order. Ultimately, positive cash flow is what will keep you farming for years to come.
Paul Dietmann is a Senior Lending Specialist with Compeer Financial. For additional insights from Dietmann and the Compeer team, visit Compeer.com.