With ever-changing markets and extreme volatility, forecasting cash flow may seem an impossible task. Although no forecast is ever perfect, the more information you gather and the more often you adjust the numbers to reflect reality, the closer you get to hitting the mark.
"We have so much volatility now that you have to spend a bit more time on your finances and have a good feeling for where you are at," says Dale Nordquist, associate director of the Center for Farm Financial Management at the University of Minnesota.
Forecasting cash flow is especially important in volatile markets in order to have a road map for planning, notes Pauline VanNurden, farm business management instructor at Riverland Community College’s Owatonna, Minn., campus. "It helps you to see what working capital opportunities you can take advantage of and when you need to pull in the reins," she says.
In addition, cash forecasting is important in managing relationships with lenders. When it comes time to approach the bank, having a solid cash forecast and good accounting record can be a huge
help, as banks are coming to expect that level of detail and planning.
In fact, as lending standards tighten, it can mean the difference between a favorable bank relationship and a closed door.
"Bank regulations have changed a lot in the past few years," VanNurden says. "Bankers are under more scrutiny than ever before, and they are scrutinizing their borrowers more as a result. Having a detailed, quality cash flow forecast is tremendously important when a producer is trying to get an operating note, a machinery note, or what have you. It is critical in getting that lender relationship going and continuing to move it forward."
Forecasting the Unexpected. When putting together a forecast, start with a balance sheet, get a handle on current inventories and go from there. Look at the physical side of the business: estimate yields, production levels and market prices to get an idea of revenue potential.
In addition to unpredictable revenue, volatility in inputs can throw forecast numbers into disarray. Most producers actually do a pretty good job of projecting the expense needs of their operation,
Nordquist notes. "It’s the income side, which is also obviously volatile, that is harder to project," he says.
One strategy to help prepare for unforeseen expenses is to put a number in your forecast even for items that you may not expect to come into play. This can help when it becomes necessary to adjust the numbers for changing conditions or to plug in overlooked expenses.
VanNurden suggests using a three-year average on overhead costs that are not directly related to crop inputs so you can understand the trend for such things as repairs, fuel and utilities. "A comparison of three years can give you a good idea of where you sit," she adds.
Looking back at accounting records is helpful when deciding what to include in your cash forecast and to ensure no expenses and receipts are overlooked.
Keep in mind, however, that the past seldom gives an accurate picture of the future, so it is important to look at the present and think to the future as well when plugging in your numbers.
"When they are budgeting, people often look at what they spent during the past year to predict the coming year, but that is not always the best predictor," explains Alyssa Martin, executive
partner in advisory services at Weaver LLP.
Remember the Fundamentals. It is more accurate, Martin says, to look at and analyze the fundamental activities that create the cost or revenue—in other words, the current or future known expense.
"Think of your real measurement points. That is a more practical way of budgeting," she says. "Then you can take that and compare it to prior years. If you start with only historical data, you could be off in predictive points."
Martin adds: "Especially now, given how much things have changed in the past two years in the agriculture industry, if you don’t recognize those changes and just look at history, your numbers could be quite a bit off."
At the end of the day, no cash forecast is 100% accurate. But the more regularly you update your figures, the more accurate they will be—and the more useful they will be in keeping your farm’s financial health in check.
Common Missed Expenses
When preparing a forecast, it’s not unusual to forget expenses or other items that could throw off your calculations.
Frequently missed items include call sales; livestock replacement projections; and less tangible expenses, such as storage costs that will be incurred before commodities can be sold.
"Capital purchases are often overlooked," says Dale Nordquist, associate director of the University of Minnesota’s Center for Farm Financial Management. "Try to put in a number for capital purchases, even if you think you won’t buy anything this year. Whether an unexpected opportunity arises or a piece of equipment breaks, something will inevitably come up. If you have a number in there, you will have money set aside for that."
- March 2011