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Twelve steps to cash-flow budgeting

William Edwards Published on 12 November 2010

How much financing will your farm business require this year? When will money be needed and from where will it come? A little advance planning can help avoid short-term shortages of cash. One useful tool for planning the use of capital in the farm business is a cash-flow budget.

A cash-flow budget is an estimate of all cash receipts and all cash expenditures expected to occur during a certain time period. Estimates can be made monthly, bimonthly or quarterly, and can include nonfarm income and expenditures as well as farm items. Cash-flow budgeting looks only at money movement, though, not at net income or profitability.

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A cash-flow budget is a useful management tool because it:

• forces you to think through your farming plans for the year

• tests your farming plans, such as if you will produce enough income to meet all your cash needs

• projects how much operating credit you will need and when

• projects when loans can be repaid

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• provides a guide against which you can compare your actual cash flows

• helps you communicate your farming plans and credit needs to your lender

Getting started
Developing a cash-flow budget for the first time will not be easy. Following a step-by-step approach can make the task less difficult, though. There are many personal computer programs available for developing cash-flow budgets. Or you may want to develop your own. In any case, the following steps can be applied.

1. Outline your tentative plans for livestock and crop production for the year.

2. Take an inventory of livestock on hand and crops in storage now. If a recent financial statement is available, information found under the current assets section can be used.

3. Estimate feed requirements for the proposed livestock. Your own past feed records may be a good guide. Adjust feed requirements if livestock will complete only part of the feeding program during the budget year. It also is helpful to divide requirements for homegrown feedstuffs between the periods prior to harvest and following harvest.

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4. Estimate feed available. List beginning inventories prior to harvest, and expected new-crop production after harvest. Finally, estimate the quantity of feed purchases needed, if any, and the quantity available to sell. Once your feed supply and feed requirements are estimated, you may want to adjust the livestock program to fit them.

5. Now you are ready to start with the actual cash-flow budget. First, estimate livestock sales, based on production and marketing plans.

• Start with livestock on hand, then add livestock to be produced during the year. Exclude animals to be carried over to next year or held back for breeding stock.

• Include sales of breeding stock that will be culled.

• Include livestock product sales, such as for milk or wool.

• Use your best estimate of selling prices based on outlook forecasts or marketing contracts.

• Reflect expected seasonal price patterns when appropriate, rather than using the same price all year.

• Stay on the conservative side. If your plan will work at conservative prices, it also will work at better prices.

• Some producers prepare budgets at two or three price levels for the major products they sell. This helps them identify the amount of price risk they face.

6. Plan sales of nonfeed crops and excess feed.

• Consider crops in inventory at the beginning of the year as well as crops to be harvested during the year. Plan to carry over grain for feed for next year plus other crops normally sold in the following year.

• Plan timing of sales according to your normal marketing strategy.

• Follow the same guidelines as in Step 5 for estimating crop prices. Look at outlook forecasts, consider seasonal price patterns, and use conservative price estimates.

• Multiply quantities to sell by anticipated prices, and carry the totals to the budget form.

• After the initial cash-flow budget is completed, you may want to revise your marketing plans to meet capital needs throughout the year.

7. Estimate income from other sources, including:

• USDA farm payments

• custom machine work income

• income from off-farm work, rental property, or other business activities

• interest, dividends, patronage refunds, etc.

Last year’s additional cash income listed on your income tax return is a useful guide.

8. Project crop expenses and other farm operating expenditures.

• Last year’s expenditures are a good guide. Adjust for changes in price levels.

• If cropping plans will be different this year, detailed field-by-field production plans or field maps can be used to estimate expenses.

• Expenses determined by contract, agreement, or law can be estimated directly from contract terms, unless rates are expected to change. These include property taxes, property and liability insurance premiums, and fixed cash rents.

• Expenses should be spaced through the year based on your best judgment. Some will fall mainly during certain seasons, such as machine hire, part-time labor, and crop expenses.

Remember to place these expenses during the period of payment, not the period of use. Some expenses will be spread through the year but will have definite seasonal peaks. Fuel, machinery and equipment repair, and utilities are examples. Other expenses may be spaced evenly through the year, such as vehicle operating expenses, livestock health and supplies, and purchased feed.

9. Consider capital purchases such as machinery, equipment, land, or additional breeding livestock. Major machinery expenses such as a tractor overhaul also can be included here, as well as construction or improvement of buildings. You may want to complete the rest of the cash-flow budget first to see if major capital expenditures will be feasible this year.

10. Summarize debt repayment. Much of this information can be taken from your most recent net worth statement. Include only those debts already acquired at the beginning of the budgeting period. Calculate interest that will be due at the time the payment will be made. Remember, the net worth statement may show only interest accrued up to the date of the statement.

11. Estimate nonfarm expenditures.

• Adjust last year’s living expenses for changes in family circumstances and inflation. Remember to allow for possible purchases of vehicles, furniture, appliances or major repairs and contributions to retirement accounts.

• A tax estimate made at the end of the year for tax management is helpful for projecting income tax and Social Security payments to be made for last year’s income. Your estimate can be revised when your actual tax returns have been completed.

12. Sum total cash inflows and total cash outflows.

• Add total projected cash inflows for the year and for each period. Add the total inflows for each period to check that they equal the total projected inflows for the year.

• Add total projected cash outflows for the year and for each period. Add the total outflows for each period to check that they equal the total projected outflows for the year.

• Subtract total cash outflows from total cash inflows to determine the net cash flow for each period. Add the net cash flows for each period to check that they equal the total net cash flow for the year.

If the estimated net cash flows for the entire year and for each period are all positive, you have a feasible cash flow plan. If the net cash flows for some periods are negative, some adjustments may need to be made.

Monitoring cash flows
Review your cash-flow budget from time to time during the year. Prices and costs may differ from your estimates, or production plans may change. Monthly bank statements and canceled checks are a good source of cash-flow information against which your budget can be compared. This will help you anticipate changes in your needs for cash and credit later in the year. You may even need to prepare a revised budget for the remainder of the year.

Developing a cash-flow budget for the first time will not be easy. Close communication with your lender is important. By planning where you are going financially, you can increase your chances of arriving there safely. Cash-flow budgeting is an essential part of sound financial management. PD

—Excerpts from Ag Decision Maker, Iowa State University Extension Service

William Edwards
Department of Economics
Iowa State University

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