Asset rich, cash poor – Understanding cashflow in farming businesses
We’ve long heard the phrase, that farmers in particular have plenty of assets, but not much in the way of cashflow. This flows through to the presumption of many hours of hard work, but precious little in the way of disposable income to show for it.
There is no disputing the fact that farming is a 12 hour a day, seven day a week job, at a minimum. Its dirty, isolated and dangerous. Yet most farmers also find it personally rewarding and enjoy both the satisfaction and the challenges of working on the land.
One of the key challenges is planning for hard times and managing cashflow. Looking at the options of debt reduction, capital investment, tax planning and making sure there is a bit leftover for personal reward as well.
There is an old saying, that you can only spend a dollar once, and in planning for cashflow management, this is very true. There is also no “one size fits all” solution. Each business needs to look at its current situation, the medium to long term goals of the business, and plan its cash use to fit.
The cash generated from the business operations is broadly spent on the following items:
Long term debt reduction (or capital saving)
Short term machinery finance payments
Personal investment (FMD’s, superannuation, share purchases etc)
The biggest challenge is, that to improve one category, you have to take from another. For example, to reduce income tax, Farm Management Deposits (FMDs) can provide a very effective way of saving pre-tax income for a rainy day (or a long period of no rain!). However, in order to have the extra cash to contribute to FMDs, either debt reduction or personal spending need to be sacrificed in some capacity. If debt reduction is, or needs to be, a core focus, then tax reduction techniques such as FMD use may not be available.
Like everything else, the amount of capital required to be invested into machinery and land differs from business to business, and so much depends on the production mix, the risk associated with the location and the goals of the owners.
Its beneficial to work out a five year rotation of machinery requirements, which allows your business to map out cash inputs required over that time period. Whilst spending might need to be cut during an extended dry spell, having a solid long-term plan and capital resources to assist fund this on an average basis, helps to ensure that your business can maintain its investment levels year in and year out, and not face a significant catch up spend when seasons come good again.
Once the ideal machinery reinvestment amount is identified, the business can examine how much is left to invest into repaying core debt or saving for expansion. Whilst variations in income due to seasonal conditions means that it is difficult to commit to a certain repayment every year, it is possible to arrive at an average, which allows calculation of longer term timeframes. This means it is possible to plan for times when expansion is possible, or what net assets might be on retirement.
It’s a touchy subject and another one that varies wildly. Spending straight out of the business cheque account can get even the closet miser into strife, as it’s so hard to keep a track of what is spent. Ideally, each farm business should identify a reasonable monthly wage for each working partner, and transfer that into personal bank accounts. This allows for both good business cashflow management and separates personal spending decisions from business spending decisions. This is even more important in multi-generational or multi-partner groups where differences in views on personal spending habits can vary wildly.
Time off the farm is also important for recharging and strategic thinking. An annual harvest bonus or shearing bonus can help to provide additional cashflow to fund these activities. Again, its important to tailor this to your individual business and its means. As much as possible, this should be worked into the long-term plan for the business, so that one bad year doesn’t interrupt the important task of getting your mind out of the day to day business.
The benefits of farm life, and habits picked up from past generations, can mask just how high personal spending is as well. It’s often useful to run a comparison to what would need to be made on a town-based salary job in order to maintain the same standard of living. When you add in the cost of accommodation, power, telephone, running costs for two vehicles, repayments for at least one vehicle, and private health insurance payments (often paid out of the farm account), then the gross salary comparison adds up very quickly. For example, a couple drawing $5000/month from the farm account to live on, would potentially need an after tax equivalent of $100,000 a year to live on. If they are both working full time, they would need to be making $65,000 each to sustain this, and there would be no savings. If only one was working, that one person would need be making $145,000, and again there would be nothing left over for savings.
Given the long hours of hot and dirty work, farmers most certainly deserve to be able to reward themselves. It is however worth bearing in mind what the comparative income is, as that knowledge will help with other capital allocation decisions.
All of the above hinges on working with a fixed average income (acknowledging that annual results can vary wildly). If there are bigger and bolder cash requirements, then its time to drill down to the enterprise mix and profitability. Examine industry best practice, look at returns per hectare and assess ways to lift the gross return that require less inputs. Increasing productivity is one of the biggest challenges in any industry, and reviewing new techniques or technologies can be of great assistance in this area.
It’s never too late…
Whilst farming is a wonderful lifestyle, it’s not for the faint hearted, and it should always be treated like the tough business that it is. Effort put into understanding the relationship between profit and cashflow, and then the usages of cash in terms of investment and spending, will pay huge dividends. Being armed with this information will assist your business to make effective long term strategic decisions and put you in the best possible position to be a modern farming success story.