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.
For example, if you have both grain and livestock operations, but the grain is grown as livestock feed, don’t try to account for every bushel of grain from your crop production enterprise to the livestock operation in an overall farm cash flow budget. That’s way too labor-intensive and provides little value, Aukes says.
Instead, keep cash flow budgets separate for each enterprise, and use market prices to account for value. That means assigning market prices to the grain enterprise and market feed costs to the livestock enterprise.
6. Do it for you, not for your banker. Less than 10% of producers do a good job of preparing their cash flow, primarily because they prepare them only when their banker requires it, Aukes says. A better way is to use the budget as it is supposed to be used—to detect a problem one or two quarters out and then find a solution to the problem. Your lender will appreciate it—and you will too because you’re using your budget for its intended purpose, Aukes says.
7. Don’t worry about getting it right. "Every cash flow budget is going to be wrong; it’s the process it forces you to go through that’s vital," Aukes says.
The process is immensely worthwhile and can give you a road map for where you’ve been and where you’re going, he adds.
"It’s a powerful management tool. The fact that variables are likely to be very wide in 2013 is just a cop-out," Aukes says. Variables are often wide and changeable.
8. Get it done, and do it yourself. The biggest mistake many farmers make is that they don’t do a cash flow budget at all. Or if they do, they have someone else do it for them and don’t refer to it when making decisions.
Without a cash flow budget, it’s impossible to know your break-evens, your cost of production and many other important financial ingredients, says Brian Briggeman, ag economist at Kansas State University.
If creating a cash flow budget seems too complicated, or you want to bring in a professional to help, plenty of resources are available from landgrant universities, financial consultants and the Internet.
9. Prepare for the unexpected. With back-to-back record years for profits, some producers, though certainly not all, have become lax about factoring unexpected events into their cash flow budget, says Ryan Cox, vice president of agricultural banking at Central State Bank in Muscatine, Iowa. That’s the No. 1 cash flow mistake he’s seeing right now.
Cox, who also farms in Illinois, says he fears that price and yield projections for 2013 will be on the high end, and some costs on the low end. For instance, he warns against plugging in corn prices based on recent highs, and wants producers to be prepared if corn takes a turn toward $5.
10. Update budgets regularly. "Cash flow can change every day," Cox says. Because variables are moving up and down with great regularity, he advises farmers to update cash flow budgets on a monthly basis so they know constantly where they’re at, and can take action to protect profits.
In Aukes’ view, monthly might be overdoing it, however. If you’re a wheat producer with little changes, updating twice a year might be sufficient. Update quarterly if you’re a farrow-to-finish hog producer. "But if you make a future sale, change the budgeted number to a known number and be done with it," he adds.
You can e-mail Ed Clark at email@example.com.
- December 2012