10 ways a budget can point you in the right direction
When it comes to cash flow budgeting, don’t sweat the small stuff—that is, don’t get mired in the insignificant details, especially in a highly volatile and explosive year like 2013 promises to be. Revenues, expenses and actual production could be all over the board. Only time will tell.
More important than nailing the numbers just right is creating a constructive process that can be a powerful decision aid when volatility escalates, experts say. Most farmers don’t enjoy the process of developing and updating cash flow statements. But those who learn how to make cash flow budgeting their friend are rewarded with higher farm profits and a conducive working relationship with their lenders.
Even though profitability isn’t an issue for many crop producers right now, lenders are demanding more financial documentation more frequently. That’s not only to please their loan committee and bank president, but also regulators who are monitoring every move.
Master the following 10 financial pointers to correct common cash flow problems as you develop a budget for 2013.
1. Don’t be overly optimistic. A two-year study of a group of Farm Credit System borrowers found that on average, they overestimated cash receipts by 15% and underestimated expenses by 17%.
Likewise, many producers underestimate their equipment purchase needs and overestimate their crop yields, says University of Minnesota ag economist Dale Nordquist. A good rule of thumb is that you’ll need to replace 10% of your equipment each year, he advises.
In addition, many producers either underestimate family living expenses or don’t have a handle on what they are, Nordquist says. One reason bankers tend to back off producer cash flow statements is because they think the numbers are generally inflated.
2. Conversely, don’t be too pessimistic. Some producers are so conservative with their assumptions that their cash flow conclusions bias them against opportunities, be they marketing or investment opportunities, Nordquist says. Being too conservative with your assumptions can actually hurt your bottom line.
3. Strategize more "what-if" scenarios. Danny Klinefelter, an ag economist at Texas A&M University, says that when preparing cash flow budgets, some producers just look at best-case and worst-case scenarios, when they should be looking at a set of "what-if" possibilities.
"The most important question in cash flow budgeting is not just ‘what if,’ but rather ‘what do I do if,’" he adds.
For example, crop insurance revenue will likely be off by 10% in 2013 because of this year’s yields. Next year, yields could stay below trend due to drought conditions lingering in much of the western Corn Belt. Plug those numbers in. Develop your own matrix based on your specific farm history, Klinefelter adds.
4. Use a crystal ball. The past is useful to calculate some variables, such as yields for crop production and livestock rate of gain, both of which are generally highly predictable. For others, a five-year average bears little resemblance to present conditions, says Bob Aukes, a farm management consultant with AG Finance, Inc., in Des Moines, Iowa. Variables that fit within this category are land rents, seed, and chemical and fertilizer costs, for which present costs are the only ones worth using.
5. Simplify, simplify. Some producers get too bogged down in complicated details, Aukes says. Budgeting is hard enough as it is, so don’t make it more burdensome than it needs to be.
- December 2012