The business of farming is full of uncertainties. What crop prices will the year bring? What destructive pests will come knocking? Will the weather cooperate? The list of unknowns is extensive.
Despite the many unknowns, having an accurate projection of your operation’s future financial performance is completely attainable. In fact, it’s not only within reach, it’s a huge competitive advantage.
Knowing your projected finances allows you to make informed investment decisions and gain a solid understanding of the value you need to attain for your production while also inspiring trust from your banker. By taking the time to analyze the current and future cash flows for your business, you set your farm up for long-term success.
Knowing your costs
Developing projections for your operation can be very enlightening. Cash flow is a key building block in forming financial projections and forces you to look at costs and how to manage those costs effectively.
The first step to gaining a good understanding of costs is to put each expense into one of two categories: fixed or variable. Fixed costs, which are constant regardless of your business activity or production levels, include a lot of the overhead costs for your business. When building this portion of your worksheet, consider costs such as rent (if the rent amount is not based on revenues) and employee salaries, taxes and other labour-related costs. When building your financial projections, it’s important to bear in mind that you have less ability to control your fixed costs in the short term. Think about the timing of the actual payments of these costs. When does that insurance payment actually come out of your bank account? Is it a once-per-year cash flow or is it a monthly cash flow?
Variable costs are the opposite in that they fluctuate based on the activities of the business, and they really hinge on prior decisions on the size and nature of your farm. How broad are your operations? What type of crops do you grow or livestock do you raise? You have far more control over variable costs — you can generally decrease them simply by cutting back on volume. These include expenses such as utilities, fertilizer, seeds and animal feed. The list can be vast and is unique to each operation. Consider again the timing of the cash flows related to variable costs. Though fertilizer may be a variable cost, when does the payment actually come out of your bank account?
Finally, project your revenues and again plan for the timing of the cash flows to come from those revenues. Thinking about variable and fixed costs, revenues and the timing of those cash flows will help you to understand not only how profitable the farm should be this year but also when you may have some cash flow shortages and need some help from your banker.
Debt versus equity
Another set of factors to consider are your two sources of financing — debt and equity. Debt versus equity is the eternal debate and each has its advantages and disadvantages. Debt tends to take the fall as the bad guy, perhaps because it is so inflexible in nature. Regular payments must be made to the lender on both the interest and the principal and there’s no grace period.
On the other hand, while equity provides much more flexibility, it has a high price tag. Your farm’s shareholders are typically looking for an even greater return than your bankers are. While more expensive than debt, equity provides the option of not making that regular payment to the investor, and opting out of dividends when the business is short on cash.
Building debt and equity into financial projections for your operation is really quite simple. Debt (interest and principal payments) would show up as a regular cash flow, which can be accurately projected across time. Equity, on the other hand, often only shows up in projections when there is an excess of cash, which means dividends would be paid to any investors. This would also show up as cash outflow.
Putting the numbers to work
You may already have a good sense of your fixed and variable costs as well as your debt and equity implications, so it’s time to put that knowledge to work for you. Along with those costs, pull the business apart into as many components as possible. Look beyond expenses and revenues and think about every single dollar that flows in or out of your farm.
Throughout this process, many growers in my class at Syngenta Grower University indicated that they really learned a lot about their farm. Upon returning for the alumni program, it was amazing to see the difference in their financial tracking and projection worksheets and the amount of detail they were able to produce over time. There are an incredible amount of factors that play into the mix on any activity, right down to the inputs and outputs of each individual plot of land.
While there are peaks and valleys on any farm, it’s important to make monthly, not annual, projections to avoid financial surprises. What have you planted? What are the associated costs? What is the timing of these costs? What are the projected revenues and how much is secured through forward contracting?
In-depth projections will make your banker more comfortable, which is a crucial component for success, but they can also gives you an edge with both human resources and sales. You can go into salary negotiations knowing the maximum available increase for each employee, and enter any negotiation knowing your absolute bottom line.
Financial projections are crucial for understanding the stability and overall profitability of your operation. By taking advantage of the information already at your disposal, you can gain a better understanding of the future finances of your business. Start turning that knowledge into power and get familiar with how each factor affects the bottom line. Know your numbers — take some of the uncertainty out of farming.CG
Mary Heisz is a lecturer in the Managerial Accounting and Control Group with the Richard Ivey School of Business at the University of Western Ontario in London, Ont. She teaches numerous financial courses as part of the Syngenta Grower University programs, designed to help Canada’s top producers run their operations with increased confidence and profitability by adopting the most effective business management skills and techniques.