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Cashflow in farming

Why good cashflow management is key to a successful farming business

Cashflow is still king when it comes to business operation. Understanding how cashflow works, which factors affect it and what tools are available to help you manage it, is vital to running a farming business in an efficient and controlled manner.

Oliver McEntyre, our National Agriculture Strategy Director, explores how good cashflow management can have a positive effect on your business operations.

Farmgate prices and cashflow

When farmgate prices are tight, managing cashflow is key. But once the price lifts and more funds become available to help manage and improve the business, good cashflow management is still vital to enable your business to develop.

Cashflow management is about managing variable costs and everyday items used to operate the business, such as feed, fertiliser, spray and fuel. It’s also about having a solid understanding of the effects that higher or lower prices at the farmgate – inwards or outwards – can have on your bank balance.

All farm businesses should know what an increase or decrease in price at the farmgate means for income. But what about the necessary adjustments in cashflow management to counteract that movement? Small movements should be easily accommodated within existing cash, overdraft or finance facility. But larger swings upwards may enable swifter small-scale investment, or the ability to forward purchase inputs in bulk for a better deal, therefore cutting production costs.

If the implications are known, then more proactive management decisions can be taken. Likewise, downward movements in farmgate price may mean investment plans need to be reined in or postponed, to ensure the investment doesn’t starve the business of cash. Alternatively, a more ‘little and often’ approach to purchasing inputs might be required to maintain the cashflow month-by-month.

Business funding requirements

The funding requirement of any business is made up of four distinct areas

Variable costs

Costs that vary with the size of enterprise and can usually be easily attributed to a particular enterprise within the farming unit, for example

  • Feed
  • Fertiliser
  • Seeds
  • Vet and medicines/vaccines
  • Contractors
  • Bedding
     

Fixed costs

Costs that remain broadly similar regardless of enterprise size, or are difficult to attribute to one specific enterprise, such as

  • Water
  • Fuel and machinery
  • Rates
  • Labour

Rent and finance

The cost of rent and financing the business. Within the profit and loss account, it won’t include capital – but within a cashflow forecast, the capital repayments should always be included.

Drawings or dividends

The money taken out of the business for personal use, ie the wages and/or the salary of the partners or directors.

Plug the funding gap

Perhaps the most important factor to understand is the correlation between days it takes to receive money into the business, and the timing of paying for the inputs. 

How long it takes to receive payments is known as debtor days. It’s an easy calculation but one that agriculture businesses, as a rule, don’t need to consider. The payment structures under which it usually works for goods can show a somewhat distorted view with seasonal businesses, therefore arable farming or seasonal field-scale veg production wouldn’t benefit from this calculation.

Of more interest in an agricultural context is how long it takes your business to pay its suppliers, known as creditor days.

The difference between the two is the funding gap required to operate the business. For example, if the farm is receiving payment for produce six weeks after supply, but regularly pays its bills at two weeks, the four-week gap between paying for inputs and receiving the income they generate will need funding from somewhere.

As a rough calculation of the amount of working capital required, the gap between payments here is four weeks. Although agriculture is a very seasonal business, the total cost of all outgoings in the year can be divided into weekly averages, then multiplied back up to whatever the funding gap is – in this case four weeks.

It can be adjusted for seasonality. Livestock enterprises, for example, will see reduced feed costs during the grazing period, so a seasonal adjustment downwards with its base as the reduction in feed costs. Conversely, these can be revised upwards for winter.

For very seasonal businesses – like those focused on combinable crops – the cashflow requirement can only be gauged correctly from budgeting and knowing the input costs. This gives an overall figure required for the growing season, which would need to include all fixed and variable costs.

This is the difference between the time it takes to receive cash in comparison with the time it takes the business to pay invoices. The decision then, is to decide how to fund it. It could come from cash reserves or, potentially, a working capital facility might be required from the bank.

The faster the turnover of stock, the shorter the interval between paying suppliers and receiving payment for product. In the context of farming, if you’re buying in-store animals for finishing, the quicker and more efficiently you can move those animals from purchase to slaughter, the shorter the working capital requirement and the quicker you’ll receive payment after paying for the animal.

Why managing cashflow is vital

  • It puts you in control of your business, as well as helping you to better understand your production costs
  • You may be able to negotiate better supplier terms – the quicker you pay your suppliers, very often the lower the cost of the goods bought in. When a business knows its cash cycle, it knows when it can afford to send cash out of the business;
  • It can build more reliable business relationships – making payments within the terms of a supply agreement is key to having a positive and reliable business relationship with suppliers. The better the relationship, the more likely it is that the two parties can work together.

Control your cash so it doesn’t control you

It is always worth remembering the old adage ‘cash is king’, because it’s lack of cash that stifles business. Make sure you control the cash in your business, rather than a lack of cash controlling the business’ management and actions.

Businesses that run out of cash are known as overtrading, ie running out of the cash needed to function. This happens when more invoices are coming in than payments being made for goods. It’s more common than people think in agriculture, though it’s relatively easy to solve by moving out payments to creditors or changing the payment cycle for produce. Small adjustments either way can make a big difference to a business’ cash cycle. 

Overtrading is very different to loss making. Loss making is when a business is selling for less than the total cost of production, whereas overtrading is when the cycle is imbalanced.

Take steps to help manage your cashflow

  1. Work out your overall costs within the production payment cycle – these are the basis for cashflow forecasting and can be used in greater detail within a budget.
  2. Calculate the working capital available in cash to service this.
  3. Talk to the bank to ensure any funding gap is agreed and used to meet those costs as they arise.

Talk to us today if you’re looking to improve your cashflow or develop your farming business.

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