Cash flow basics: Don't stress, plan

Paul Dietmann
Compeer Financial

For some farmers, cash flow management consists of paying bills until the checking account is empty, running credit cards up to their limits, then hoping the mail carrier delivers a check or two instead of just more bills.

Tight cash flow can be challenging, even for the most experienced producer.

Tight cash flow can be challenging, even for the most experienced grower. For a beginning farmer, however, a cash flow crunch can quickly become a disaster. Bills are left unpaid, credit cards are maxed out, the credit score starts to slide and — within months — the farmer can be out of business. 

If handling your farm’s cash flow by the seat of your pants is stressing you out, cash flow planning and analysis will help to ease your anxiety.

Cash flow projection

An annual cash flow projection is a very useful tool for a farm. You plot out on a month-by-month basis when cash income will be received and when cash expenses will need to be paid. The projection will help you anticipate in which months your cash inflow will not meet your needs. Most importantly, you will be able to plan ahead to cover cash shortfalls without tapping credit cards, leaving bills unpaid, and possibly wrecking your credit score.

A cash flow projection is a prediction of all of the cash that is likely to flow into and out of the farm operation during a given period of time. Cash flow planning starts with a month-by-month projection of the cash flow you expect to see in the year ahead. The projection can begin on January 1 and follow the calendar year. Or, it can start when something big is expected to happen that will impact the farm’s cash flow such as a purchase of land, construction of a new building, or taking on new debt payments.

Paul Dietmann

Many producers use a simple spread sheet or log to document the money coming in and out of the operation. The cash inflow side includes revenue generated from the sale of farm products, government program payments, machinery and breeding livestock sales, income from off-farm employment, and proceeds from new loans. Cash outflow includes operating expenses, principal and interest payments on loans, funds used for capital purchases, income tax and Social Security payments, and family living draws taken by the farm owner.

Nearly every farm will have months — possibly even years — when cash flow from operations is negative. Oftentimes farm cash flow is poor in the summer. The bills for seed and other crop inputs have been paid, there might be bills for machinery repairs, and there isn’t much to sell until later in the year.

What About a shortfall?

If you develop a cash flow projection and predict that cash flow is going to be short in some months, you have several options to cover the shortage. Maybe you can build up your cash reserves during good months. Maybe you could change your farm enterprises and add one that brings in cash flow during months you would otherwise fall short.

Perhaps you could pick up some off-farm work at key times of the year. You might be able to re-schedule the payments of some bills or loan payments to more closely match your cash flow. Or, you could set up a line of credit with a lending institution, which can be tapped in lean months and paid off in good months.

It’s awfully tempting to get through a few months of tight cash flow by using the handiest source of short-term credit: credit cards. With their high interest rates, credit cards are the worst way to cover cash shortages unless you diligently pay them to zero every month. If you decide to use short-term credit to bridge your low-cash months, work with a reputable lender and apply for a farm operating loan or line of credit. The terms will be much better than paying credit card interest rates of 18 percent or more.

It’s awfully tempting to get through a few months of tight cash flow by using the handiest source of short-term credit: credit cards.

Over the long run, the farm operation should generate enough positive cash flow from operations to pay all of its operating expenses, make loan payments, pay the farm owner a decent draw, and have enough cash left to replace some capital equipment and put a bit into cash reserves.

If the operation consistently runs negative cash flows, you should undertake a more in-depth financial analysis and consider making structural changes to your farm business. This sort of analysis is done at the end of the year, and looks back at the farm’s actual cash inflows and outflows.

Analyzing cash flow

Breaking out the farm’s cash flow will tell you if the farm operation paid its own way or was subsidized by other sources of cash such as off-farm income, proceeds from new loans, or with sales of capital assets such as equipment or breeding livestock. To analyze cash flow, break it out into three distinct categories:
1. Cash flow from operations: Cash flow from operations includes all of the dollars that flow in and out of the farm in normal, day-to-day activities. Cash comes in from sales of milk, cattle, grain, vegetables, and other products. Cash might also come in from government payments and custom work. Cash flows out as you pay for seed, feed, fertilizer, fuel, and other operating expenses. We want cash flow from operations to be positive every year.

2. Cash flow from investing activities: Cash flow from investing activities refers to capital investments in the farm, not the dividends you received from investments in mutual funds. Cash inflow in this category generally comes from sales of machinery, breeding livestock, or land. Cash flows out to pay for purchases of these capital investments.

Cash flow from investing activities — whether positive or negative — can offer clues to other aspects of farm management. For some farms, cash flow from investing activities might be positive because the farm does a great job with heifer calves and always has excess breeding stock to sell. For others, it might be positive because machinery is being sold to cover shortfalls in cash flow from operation and nothing new is being purchased. Cash flow from investing activities might be negative because the farm is using positive cash flow from operations to make capital improvements, which is good.

3) Cash flow from financing activities: Cash flow from financing activities considers funds provided by lenders as well as funds made available by the farm owner. Cash inflow comes from new loans and from off-farm income. Off-farm income is included because it’s money that could be tapped by the farm if needed. Cash flows out to make principal and interest payments on loans and to provide for cash withdrawals by the farm owner.

It’s helpful to look for patterns in cash flow from financing activities. Are loan payments being made on time? Are principal balances being paid down faster than new loans are taken out? If the farm has an operating loan, is the balance being paid down or only the interest being paid? Is the owner able to take a regular cash draw out of the farm, or is he or she putting more money into the farm?

The farm operation should generate enough positive cash flow from operations to pay all of its operating expenses and have enough cash left to replace some capital equipment, make loan payments, and pay the farm owner something back for his or her investment in the farm. If cash flow is coming up short, a more detailed cash flow analysis is in order. Ultimately, positive cash flow is what will keep you farming for years to come.

Dietmann is a senior lending officer at Compeer Financial