One of the most common problems that occurs when operating a business is insufficient cash flow. Revenues are larger than costs for a few months; then suddenly, there is not enough money to pay the bills. Why does this happen? The primary reason is the lack of planning.
“A little advance planning can help avoid short-term shortages of cash,” says William Edwards, extension economist at Iowa State University. “A useful tool for planning the use of capital in the ranch business is a cash flow budget. The cash flow budget is an estimate of all cash receipts and all cash expenditures that are expected to occur during a certain time period. Estimates can be made monthly, bimonthly, or quarterly, and can include non-ranch income and expenditures as well. Cash flow budgeting looks only at money movement – not at net income or profitability.”
Danny Klinefelter, Texas A&M AgriLife Extension Service, lists the following uses of the cash flow budget:
1. Provides the best measure of liquidity – Your ability to meet financial obligations as they become due without disrupting the continuing operation of your business.
2. Used as a projection statement – It helps you formalize the overall planning process.
3. Can assist you in evaluating borrowing needs and repayment plans.
4. Serves as a financial control tool by allowing you to monitor actual performance versus budget projections.
5. Formalizes the process on integrating plans and objectives for the various enterprises within the business.
6. Directs attention to the management of cash reserves.
7. Provides a practical tool for analyzing the impact of risk or uncertainty by allowing you to formulate projection estimates for several alternative outcomes.
8. Helps you assess the relationships among your production, marketing and financing plans.
9. As an investment analysis tool – Compare cash flows projected under current and modified operations.
The Development Process
Edwards presents the following 12 steps that can be used to develop a cash flow budget:
1. Outline your tentative plans for livestock production. How many calves will you sell? To estimate this number, you will need to know your expected calving and weaning percentages. How many cows will you cull? The proper stocking rate for maintaining pastures in good condition should drive the culling number as well the number of replacement heifers. Are you going to sell a herd bull? How often do you change bulls?
2. Take an inventory of livestock on hand. If you have excess hay or other products for sale, they should be part of the inventory. If a recent financial statement is available, information found under the current assets section can be used for this exercise.
3. Estimate feed requirements for the proposed livestock program. Your past feed records will serve as a good guide for these estimates. Adjust feed requirements if livestock will complete only part of the feeding program during the budget year. For instance, if you buy stockers in the fall and sell them in the summer, you will need to divide their feed requirements between years.
4. Estimate feed availability if you raise it. If you produce your hay, you need to list the beginning inventory and, new crop production after harvest. Estimate the quantity of needed feed purchases and the quantity of hay available to sell. Once your feed supply and requirements are estimated, you may want to adjust the livestock program to fit the available feed estimate.
5. Begin drafting the actual cash flow budget by first estimating livestock sales based on production and marketing plans. Enter the number of calves on hand, and then add calves that will be produced during the year. Animals to be carried over to next year or held back for breeding stock should not be part of this number. Sales of breeding stock that will be culled and livestock product sales, such as wool or mohair should be included in the estimate.
Your best estimate of selling prices based on outlook forecasts or marketing contracts should be used. Reflect expected seasonal price patterns when appropriate, rather than using the same price all year. Stay on the conservative side. If your plan will work at conservative prices, it also will work at better prices. Some producers prepare budgets at two or three price levels for the major products they sell. This helps them identify the amount of price risk they face.
6. Plan sales of non-feed crops and excess feed. For instance, if you raise wheat for both grazing and grain sales, estimate the amount of grain to be sold. Hay produced for sale should also be included. Consider crops in inventory at the beginning of the year as well as crops to be harvested during the year. Plan timing of sales according to your normal marketing strategy.
Look at outlook forecasts, consider seasonal price patterns and plan conservatively when estimating crop prices,. Multiply quantities to sell by anticipated prices, and carry the totals to the budget form. After the initial cash flow budget is completed, you may want to revise your marketing plans to meet capital needs throughout the year.
7. Estimate income from other sources, including:
Custom machine work income
Income from off-ranch work, rental property or other business activities
Interest, dividends, patronage refunds, etc.
Last year’s additional cash income listed on your income tax return is a useful guide.
8. Project production expenses and other ranch operating expenditures. Last year’s expenditures are a good guide as long as you adjust for changes in price levels. Expenses that are determined by contract, agreement, or law can be estimated directly from contract terms, unless rates are expected to change. These include property taxes, property and liability insurance premiums, and fixed cash rents. Expenses should be spaced through the year based on your best judgment. Some expenditures such as machine hire, part-time labor, and feed expenses will occur during certain seasons.
Remember to list these expenses during the period of payment, not the period of use. Some expenses will be spread through the year but will have definite seasonal peaks. Fuel, machinery and equipment repair, and utilities are examples. Other expenses may be spaced evenly through the year, such vehicle operating expenses, animal health supplies, and purchased feed.
9. Consider capital purchases such as machinery, equipment, land or additional breeding livestock. Major machinery expenses such as a tractor overhaul can also be included here, as well as construction or improvement of buildings, corrals and pasture fences. You may want to complete the rest of the cash flow budget first to see if major capital expenditures will be feasible. If a portion of the item will be finance by borrowing, then include the anticipated loan amount in the “Financing” section.
10. Summarize debt repayment. Much of this information can be taken from your most recent net worth statement. Include only those debts that you have already acquired at the beginning of the budgeting period. Calculate the interest that will be due at the time the payment will be made. Remember, the net worth statement may show only interest accrued up to the date of the statement.
11. Estimate non-ranch expenditures. Adjust last year’s living expenses for changes in family circumstances and inflation. Remember to allow for possible purchases of vehicles, furniture, appliances, or major repairs, and contributions to retirement accounts. A tax estimate made at the end of the year for tax management is helpful for projecting income tax and Social Security payments to be made for last year’s income. You estimate can be revised when your actual tax returns have been completed.
12. Add all cash inflows and cash outflows for the year and for each month. Compare the total of the monthly columns with the total for the annual projected outflow column to ensure that the two figures are equal. Subtract total cash outflows from total cash inflows to determine the net cash flow for each period. Add the cash flows for each period to check that they equal the total net cash flow for the year.
If the estimated net cash flows for the entire year and for each period are all positive, you have a feasible cash flow plan. If the net cash flows for some periods are negative, some adjustments may need to be made. In this situation, an operating line of credit is useful. Take your competed cash flow budget to your short-term lender and plan your financing needs for the coming year. Then review your budget several times during the year to see if any revisions are needed.