The tighter the finances get, the more important it becomes to take control of them. Chronic mismanagement of a farm’s cash flow ultimately leads to the collapse of the business. After all, farming is a business. The finances of any business that wants to make a profit and prosper must be well managed. It is the most powerful weapon in the hands of any successful farmer.
By Louis Du Pisani
1. A budget can set you free
The saying goes: Cash is king. Many farms have gone under – not because of poor production management, but because of poor cash flow management.
Farmers are often sceptical about the value of a budget and believe that a budget is useless because one cannot stick to it. However, a good budget is one of the most powerful tools in a farmer’s toolbox.
Any farm that wants to manage its cash flow effectively must synchronize the pattern of income and expenditure as closely as possible. The way to do this is to draw up a well-planned budget.
A budget is essentially the business’s business plan for the coming year. The ideal is to plan income streams so that there is enough money in the bank when a large payment must be made, such as the annual instalment on land debt. This reduces the overdraft requirement and brings significant interest savings.
Do not view a budget as a yoke. On the contrary – it frees you. It opens up a world of options for the management of the farm.
2. Good, better, cash flow management
A well-planned budget is only the first step in good money management. Thereafter, it must be actively managed on a day-to-day basis, otherwise the budget becomes nothing more than a wish list.
It often happens that the planned budget does not work out 100%. A practical example of this is the significant decrease in meat prices. Currently, livestock farmers’ meat income is 20% (and even more) lower than they budgeted for.
You can either ignore such a situation or try to rationalize it away, but the correct action is to adjust the budget immediately.
If not, the first consequence will be that the business requires a larger overdraft facility than the one already in place with the bank. It is always better to first see whether other adjustments can be made, as banks are not always willing to increase an overdraft facility during the year.
The biggest culprit in poor cash flow management is unplanned and often unnecessary expenditure made on impulse without evaluating the effect on cash flow.
This does not include expenses for equipment, such as water pumps, that break unexpectedly. When such problems arise, the budget must be adjusted accordingly.
Managing a budget is a dynamic process that requires almost daily attention from the manager. T. Harv Eker, an author known for his theories on wealth and motivation, once wrote: “You are the root of your financial success or failure. Work on the roots and the fruits will take care of themselves.” The same is true for good cash flow management.
Also read: Importance of cash flow management in business
3. Capital expenditure can bite
The most dangerous time of year for misinvestment within a farm is just before the end of the financial year, especially when it appears that the farm will have to pay taxes.
One of the options often considered to reduce the tax burden is to make capital expansions that can be deducted from income tax. There is nothing wrong with this principle, provided that the decision is based on a proper feasibility study.
Sometimes it is better to maximise the business’s after-tax profit rather than reduce the tax burden at all costs.
A good feasibility study will clearly indicate the project’s effect on the business’s short-term cash flow.
Without such a study, the outcome of a project may seem very promising, but in reality, it may put so much pressure on cash flow that the business folds before the project can finally generate a profit.
4. Be careful with the overdraft facility
One of the danger signs for a business is a chronic increase in the need for short-term financing, of which the overdraft is the most important.
If this is caused by a new project that temporarily puts pressure on the business’s cash position – and has been thoroughly budgeted and planned for – it is acceptable. If a farm experiences a prolonged drought and makes the necessary financial adjustments in time and communicates this to the bank, this is also acceptable.
However, the situation becomes problematic if it is caused by a chronic lack of profit while a profit is continuously being budgeted for, and/or by an increase in the owner’s personal spending.
The National Credit Act (Act 34 of 2005) prohibits banks from issuing credit irresponsibly. They therefore become uneasy when a business’s overdraft facility continues to increase and the bank balance never turns positive at any point in the year.
The bank is one of the farmer’s most important collaborators. You therefore want to continuously build a relationship of trust with the bank.
A business that is under increasing financial pressure breaks down this trust. Therefore, the first warning sign is an unhealthy, growing need for short-term financing.
5. Keep accounts separate
It is usually only in farms run as sole proprietorships that the owner also uses the business’s bank account as a personal bank account.
Livestock farms, due to their strong balance sheets – thanks to the high valuation of fixed assets such as land – are highly creditworthy and have relatively easy access to short-term financing (in many cases bank overdrafts).
This can create a false sense of prosperity, which can lead to ill-considered personal spending that is, in reality, unaffordable.
Just as the farm must have a budget, the farmer must also have a budget for his personal finances. He must determine from the farm’s budget what salary the business can afford to pay him.
It is good practice to transfer this salary monthly into the farmer’s personal bank account.
Also read: Avoiding legal traps: Common mistakes made by farmers
6. Large financing sums
Nothing places more pressure on cash flow than a loan whose repayment term is not aligned with the useful life of the project.
A practical example is financing a medium-term project over 12 months with a short-term loan.
Suppose the purchase price was R500 000 (at an interest rate of 10%). The monthly instalment would be R43 957. The total repayment would be R527 495, of which R27 495 is interest.
Now suppose the asset’s lifespan is five years and the loan is taken over a year. Then the monthly instalment would be R10 623, which would have a much smaller impact on cash flow.
The total repayment would be R637 411, of which R137 411 is interest. This is considerably more, but it will not destroy the cash flow.
The same applies to an asset whose financing period is longer than its useful life. In such a case, the asset would need to be replaced while the debt is still being repaid.
7. Analyse the farm’s performance
An annual economic and physical analysis of the farm is essential. The annual financial statements prepared by the accountant are not suitable for this, since they are primarily drawn up for income tax purposes and cannot be used as management statements.
An agricultural economic analysis – one that also evaluates the production figures of each enterprise within the farm – is required. It is also important to compare the farm’s figures with relevant benchmarks for that type of farming. Reliable study-group figures are important here.
This helps the farmer identify the strengths and weaknesses of the farm and each enterprise, and then take corrective action.
Find someone who can fully analyse the farm each year and is knowledgeable enough to recommend corrective steps. Keep doing this even in difficult years.
Farmers often abandon this habit during drought years. That is precisely when such an analysis is essential to eliminate similar mistakes in the future.
Also read: ‘Funding is available, but farmers must put their houses in order’ – Sylvester Lubambo
