It’s Time to Start Cash Flow Planning
- Keywords:
- cash flow
As we approach the year’s end, the agriculture outlook continues to be less than stable, as input prices and markets continue to exhibit volatility. It’s during such times of uncertainty that cash flow planning takes on added importance.
First, let’s explain how a cash flow budget differs from a profit and loss budget. A profit and loss projection is a predictor of earnings and includes noncash items, accruals and depreciation. While earnings support debt repayment in the long term, it takes cash to make the debt payments.
A cash flow budget accounts for all uses and sources of cash in your operation. It further identifies when those cash flows are moving in and out so that you can pinpoint shortfalls or surpluses. During spring planting, for example, a lot of cash goes out to get the crop in the ground, while the cash sale of those crops may not occur until much later, creating a shortfall for the period in between. In this case, the cash flow projection would account for the financing needed to get the crop in the ground or the increase in operating loan balances to cover the input costs.
Here are a few key aspects of understanding cash flow planning.
- Cash from operations. The cash provided by or used by the ongoing operations of the business. This can be reconciled back to the earnings by accounting for accrual adjustments.
- Cash from investing activity. The cash inflow our outflow from capital asset purchases or sales, or other investing activity.
- Cash from financing activity. This is primarily the cash sources and uses tied to debt. It’s also where nonfarm draws and capital contributions are accounted for.
- Net cash flow. The difference between inflows and outflows over a given period.
Avoid projection pitfalls
While cash flow planning is an essential tool, it’s easy to fall into a few traps. Make sure you avoid these common mistakes when making your projections:
- Unrealistic assumptions. Your projection should be based on realistic, current market conditions. Being too optimistic or too pessimistic does little to help you in the planning and analysis process.
- Inaccurate debt schedule. Make sure you understand your repayment streams.
- Not accounting for nonfarm cash uses accurately. Using an estimate of family living costs is not acceptable. Make sure you know the real number.
An ongoing assessment
Cash flow planning is not a one-and-done projection. Be ready to adapt by updating your cash flow projection as conditions change. This could include performing a stress test to determine the impact of a reduction in revenue or a rise in interest rates on your operation. Doing so will help you analyze your risk management plan and give you an idea of how much working capital you really need.
Conducting an enterprise analysis can help determine which parts of your operation are generating or draining cash and whether those levels are appropriate. For example, we all know replacements are necessary and that raising replacements on a dairy farm reduces cash flow. But does the drain match the replacement rate?
Cash flow planning requires a continuous evaluation to ensure that your operation maintains positive trends and eliminates negative trends wherever possible. As 2021 comes to a close, sitting down and making a cash flow projection now will help you be better prepared for the road ahead.
This article originally appeared in PDPW Dairy's Bottom Line. 
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Brad Guse
Senior Vice President, Agricultural Banking, BMO Harris Bank
As we approach the year’s end, the agriculture outlook continues to be less than stable, as input prices and markets continue to exhibit volatility. It’s during such times of uncertainty that cash flow planning takes on added importance.
First, let’s explain how a cash flow budget differs from a profit and loss budget. A profit and loss projection is a predictor of earnings and includes noncash items, accruals and depreciation. While earnings support debt repayment in the long term, it takes cash to make the debt payments.
A cash flow budget accounts for all uses and sources of cash in your operation. It further identifies when those cash flows are moving in and out so that you can pinpoint shortfalls or surpluses. During spring planting, for example, a lot of cash goes out to get the crop in the ground, while the cash sale of those crops may not occur until much later, creating a shortfall for the period in between. In this case, the cash flow projection would account for the financing needed to get the crop in the ground or the increase in operating loan balances to cover the input costs.
Here are a few key aspects of understanding cash flow planning.
- Cash from operations. The cash provided by or used by the ongoing operations of the business. This can be reconciled back to the earnings by accounting for accrual adjustments.
- Cash from investing activity. The cash inflow our outflow from capital asset purchases or sales, or other investing activity.
- Cash from financing activity. This is primarily the cash sources and uses tied to debt. It’s also where nonfarm draws and capital contributions are accounted for.
- Net cash flow. The difference between inflows and outflows over a given period.
Avoid projection pitfalls
While cash flow planning is an essential tool, it’s easy to fall into a few traps. Make sure you avoid these common mistakes when making your projections:
- Unrealistic assumptions. Your projection should be based on realistic, current market conditions. Being too optimistic or too pessimistic does little to help you in the planning and analysis process.
- Inaccurate debt schedule. Make sure you understand your repayment streams.
- Not accounting for nonfarm cash uses accurately. Using an estimate of family living costs is not acceptable. Make sure you know the real number.
An ongoing assessment
Cash flow planning is not a one-and-done projection. Be ready to adapt by updating your cash flow projection as conditions change. This could include performing a stress test to determine the impact of a reduction in revenue or a rise in interest rates on your operation. Doing so will help you analyze your risk management plan and give you an idea of how much working capital you really need.
Conducting an enterprise analysis can help determine which parts of your operation are generating or draining cash and whether those levels are appropriate. For example, we all know replacements are necessary and that raising replacements on a dairy farm reduces cash flow. But does the drain match the replacement rate?
Cash flow planning requires a continuous evaluation to ensure that your operation maintains positive trends and eliminates negative trends wherever possible. As 2021 comes to a close, sitting down and making a cash flow projection now will help you be better prepared for the road ahead.
This article originally appeared in PDPW Dairy's Bottom Line.
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