The last three of our Next Steps columns (see the ‘Related Articles’ links further down) covered the why, the when, and the what for ratcheting your farm business up a notch or two. The next logical topic to explore is the “how” of making your plans a reality, i.e. cash flow.
I’m not going to lie. I initially struggled with wrapping my head around writing about such an unsexy though of course critical component of day-to-day farm operations. What more could possibly be said that hasn’t been said before about this basic accounting exercise?
Should I go all generic and include reminders of what to do and not to do, or dig really deep and uncover some hidden secrets?
Plus, you know, numbers. There are many of us who recognize the intrinsic importance of knowing our business numbers, but nonetheless cringe at the thought of getting into some heavy explanations and in-depth analysis.
I mean, that’s what you pay your accountant for, right?
But here’s the thing. Growth plans can put pressure on a business’s liquidity, and improving cash flow can generate more funds to support that growth.
Cash-flow budgets can also help you plan for capital purchases, credit lines or loans. Plus, a cash-flow budget can help find more efficient ways to time expense payments throughout the year. It can tell you where the money went, and how and where to focus on creating extra cash, and it can provide a solid foundation for financial decisions and key performance indicators. Most importantly, it provides insight into whether you can take on an expansion project or new marketing opportunity.
Being aware of what’s coming in and out of your business is the cornerstone to building, growing and sustaining that business. To find out where you need to go, you must look at where you’ve been. Analyzing your cash flow can be a quick and easy (and not that painful!) way to do just that.
Below, you’ll find reminders, tips and some interesting approaches to improving cash flow on your farm.
It’s not just about taxes
“You have to be better before you can get bigger,” says Francois Bourgeois.
Well, that sounds like an incentive.
And here’s another, from the same source. “Basically, the biggest thing you can do to improve your cash flow is know your numbers.”
Bourgeois is a CPA, CA and partner at BDO Canada in Embrun, Ont., and he knows that farmers will often focus more on trying to decrease the amount of taxes they pay rather than on improving cash flow. “One way to look at it is that if you’re profitable, you’ll pay taxes, so it’s not necessarily a bad thing. What you should be keeping track of on a regular basis is your debt repayment and how you can manage cash flow to pay the bank.”
Bourgeois says that in order to sustain or grow your business, you need to focus on the efficiencies of your cash flow. “For example,” he says, “calculate what is your cost per kilo of milk produced or cost to grow an acre of corn. Next, figure out what is an average yield and average price you’d receive if you were to purchase an extra acre or an extra kilo of quota. This will help you to determine if you can support that extra purchase or where you need to improve before moving forward.”
He admits that some factors, like weather, are obviously out of our control. “But you can try to be as efficient as possible with the way you’re producing,” Bourgeois says. “Your timing, for example: if the weather was ideal, but you plant a week late this could result in a half-tonne-per-acre loss. In dairy the number one factor that affects cash flow is the quality of your feed. If cows produce less milk from poor feed, then you’ll have less cash on hand, so poor timing of planting and harvesting crops could again become a significant factor affecting cash flow.”
Other factors like fluctuations in commodity prices, debt repayment commitments, and operating efficiency of the farm operation also have an impact on cash flow, notes Mark Verwey, a chartered accountant, BDO partner, certified financial planner and registered financial planner in Portage la Prairie, Man.
How to improve cash flow
“Bankers do not like surprises,” says Verwey, “and are much more likely to work with you if they are kept abreast of any anticipated financial hardships. Financial institutions rely heavily on a ratio called the debt service ratio which assesses the ability of your operation to service your existing debt obligations, which includes principal and interest payments. It’s very important to understand how this ratio is calculated. It’s also a great way to evaluate expansion opportunities since it requires you to evaluate both the cash inflows and outflows of a particular opportunity (e.g. land purchase).”
Verwey suggests reviewing your cash flow at least quarterly, or sooner if a major cash payout is anticipated where a sizeable loan payment or repayment of an entire loan is imminent.
BDO uses five expense categories to determine cash flow. The list might seem complex, but it holds the key to discovering where the holes are in your cash-flow bucket:
1. Cost of goods sold (raw material inputs, e.g. feed, seeds, fertilizer, etc.).
2. Direct operating expenses to run the farm (fuel, repairs, wages, etc.).
3. Overhead expenses (fixed costs like property insurance, office expenses, etc.).
4. Capital-related costs (expenses for owning and renting assets, e.g. amortization, property taxes, interest fees, etc.)
5. Other income and expenses (e.g. insurance proceeds, AgriInvest and AgriStability income, gains/losses on sales of capital or investments).
Bourgeois comes back to his point about really understanding your numbers. You can do that, he says, by analyzing your ratios in order to see how you compare to others.
“You can also gain a lot by talking to your neighbours about your numbers,” Bourgeois adds. “It’s not like you’re two retail giants vying for the same market; you and your neighbour are going to get paid more or less the same for this year’s corn or for fluid milk, but it can be helpful to see where they’re saving or focusing on efficiencies so you can think about applying those practices to your farm.”
According to the article “Why Cash Flow is Key” on the Manitoba government’s website, there are five tactics you can use to improve cash flow for your farm business:
- 1. Increase income by increasing the scale of operations. This could mean implementing ways to bump up crop yields or quality, adding acres or livestock to your farm, or finding new sources of income through, for example, custom work, off-farm jobs or a new enterprise. You could also consider selling non-productive assets like unused machinery.
- Decrease expenses by negotiating seasonal discounts on seed, fertilizers, sprays, feed, etc. See if you can maximize advance payment programs by receiving a cash advance at a lower interest rate on operating credit. Periodically ask lenders to reassess your operating line of credit for lower interest rates.
- Decrease personal withdrawals for non-farm expenses from business accounts.
- Decrease the amount of principal owed on loans by paying them down as quickly as possible. Consider making payments on principal loan balances during high income years (but ask about any prepayment penalties first).
- Analyze your debt load to evaluate whether there’s a better way to finance your operations. For example, a loan consolidation could offer a lower interest rate and an extended repayment period which could free up some cash for current operations.
Where can you go wrong?
What are some of the most common mistakes Bourgeois sees. Farms that don’t track cash flow, focus too much on income tax, or just keep doing what their mom/dad always did and don’t assess any new information outside of what they already know.
“There’s a strong correlation between producers who have strong financial management skills and the success of their operations,” agrees Verwey. “Cash-flow management is one of those skills.”
At the same time, those producers also know that financial management pays its biggest dividends if you make it part of your routine, rather than a once-per-slog when you have to figure out those taxes.
“You don’t need to wait until the year-end to analyze your cash flow,” says Bourgeois. “With a good accounting system or a simple Excel document you can manage your cash flow monthly. The more information you have, the better equipped you will be to make decisions promptly and realign your operations.”
Farms with admirable balance sheets and income statements can still struggle with cash flow. Generating healthy cash flow on your farm is a result of timely and regular cash-flow analysis and implementing proven strategies to boost operation efficiencies.
“Cash flow is king,” reminds Bourgeois. “The future growth of your farm depends on how well you manage it.”
What can you do right now?
Go old school: grab a pen and paper and across the top of the page write down categories that affect your short- and long-term cash flow, like Debtors, Creditors, Inventory, Loans, Tied-up Capital, etc. Under each category, brainstorm as many ideas as you can for ways to create better cash flow in that category. For example, under Creditors, you could look at extending payment terms or agree on instalment payments. If people owe you money (e.g. for custom work you perform as part of your farm business), for quicker payments offer them a discount if the invoice is paid before 30 days (so you can pay your creditors) or set up automatic email payment reminders so you can get paid faster. After you’ve identified a bunch of potential tactics to increase your cash flow, weed out the less viable options by rating them on a scale of one to five. You could also take this cash-flow planning initiative a step further by listing how you will carry out each of your ideas and/or if there’s someone to whom you can delegate this task.
Bourgeois suggests taking a few minutes to work out this simple equation to help you determine how much cash you have to “play” with: Profit before interest and depreciation (or any other non-cash expenses) minus your bank requirements for next year (capital + interest payments) = what you can afford/how much you will have left over to invest to grow bigger.
You can also do a quick benchmarking exercise to help you detect inefficiencies and identify things that are working well so you can do more of them. Look at your last five years on the farm globally: what’s changed? Why? Then take your numbers to a professional to compare yours with other farms in the same sector and/or size. Benchmarking your operations against other farm businesses similar to yours will help you evaluate opportunities for improvement, set goals and performance expectations, and help you monitor that performance to effectively manage change and growth.
April M. Stewart is the owner of Alba PR, a brain-to-brain communication design firm, and the creator of “The Farmer’s Survival Guide: How to Connect With 21st Century Consumers,” a blog and workshops which look at communication impact boosters. She is also a sixth-generation Quebec dairy farmer, president of Canadian Young Speakers for Agriculture, and a member of the Canadian Agri-Business Education Foundation board. You can find her on Twitter under @FarmersSurvival.