A robust accounting system is perhaps not the most exciting part of running a farm business, but it is essential to maintain a healthy, viable business so we can continue to farm.
Accounting and record-keeping
Accounting and record-keeping are important, both to fulfil our legal obligations, but also so we can monitor and better manage our business.
If you do not measure it, how can you manage it?
Fortunately, accountants are widely available to take on the bulk of the accounting work, but as growers, we should be equally aware of the financial health of our business as we are of the health of our crops.
Just like crops, it’s better to check the situation on a regular and frequent basis so we can identify issues before they become serious, and while it is relatively easy and effective to do something about it.
Also, knowing how our business performs financially allows us to identify the strengths and weaknesses within, and then to capitalise on our strengths, and minimise the weaknesses.
Only by measuring, recording, and accounting, can we be sure of how our business is performing financially.
To that end, it is useful to understand the difference between cash and profit.
Cash versus profit
Cash and profit are not the same things, but both are equally important in maintaining the financial health of the business.
It’s not unheard of for a profitable business to fail because of a lack of cash flow, or for a business with a healthy cashflow to be unprofitable.
Cash or more specifically cash-flow is the money that flows in and out of your business throughout a given period.
Profit is whatever remains from your revenue after all costs are deducted.
In simple terms cash is like oxygen, while profit is like food; you need cash all the time, but you can survive without profit, at least for a short while.
We can think of profit as belonging to the financial accounts part of the business, something we may only identify once a year or once a quarter depending on how our business is set up.
We can think of cash or cash flow as belonging to our management accounts part of the business, something we may check on monthly, weekly, or even daily.
Due to the very nature of farms being a seasonal business means most farmers will face seasonal cashflow pressures from time to time.
Crop farmers, with one harvest a year, generally receive their income at one specific time, while their costs occur throughout the year.
The best way to manage cash in this situation is by using a cash flow, or more specifically a cash flow forecast.
These are reasonably straight forward to put together on a spreadsheet, listing the amount of projected income and expenditures and when these would occur.
This enables you to identify times throughout the year when you might run out of cash and then allows you to do something about it.
Below is a simple cash flow, a full forecast would include all incomes and expenditures, but this simplified example helps illustrate the process.
The chart shows the closing balance for each month and makes it easier to see when cash flow becomes negative.
Starting with an opening bank balance of $200 in September, the grower incurs costs associated with growing a crop, until the crop is harvested and sold for $800 in August.
Cash flow is positive from September to February, then negative from March to July, until August when crop sales puts the cash flow back into positive.
Knowing this is the cash flow requirement for the year, allows the grower to look at different strategies to manage it.
This usually involves credit from a bank or delayed payment for inputs until after harvest.
But it could also involve forward selling the crop to raise cash; agree a part payment against contracted future sales, or even adjusting your crop rotation to grow earlier harvested crops that bring cash into the business sooner in the season.
Some ideas of how to manage a cash flow shortage
- Sell stored crops – ideally, we sell crops when sale prices are at their highest, but sometimes you may need to sell early to raise working capital.
- Credit – if available, but you will need to pay for this.
- Extend repayment period – if you already have loans it may be possible to extend the repayment period to reduce the monthly cost.
- Delay capital purchases – extend the life of equipment instead of replacing it.
- Earn cash off the farm – take on other work.
- Contracting – use your equipment to provide a service for other people.
- Rent out storage – adapt existing buildings for storage or other uses.
- Machinery – own equipment with another producer to lower fixed costs.
- Lease machines – instead of owning them outright.
- Sell assets – the last resort but you may have some assets that could strategically be sold.
Not all these options will be available or suitable to each business, but this does illustrate that by measuring cashflow you are now able to manage it.
Calculate whether the business is profitable before you need to worry about cash flow, without profit, a business is not viable.
Considering then, how important profit is, it can be surprisingly tricky to define, depending on the business structure it might be expressed in different ways, for example:
- Gross profit is sales less the cost of goods sold.
- EBITDA, Earnings before interest, taxes, depreciation, and amortization, is sales less cost of goods sold and all expenses except for interest, amortization, depreciation, and taxes.
- EBIT, Earnings before interest and taxes, is sales less cost of goods sold and all expenses except for interest and taxes.
- EBT, Earnings before taxes, is sales less cost of goods sold and all expenses except for taxes.
- Net income or net profit after tax is sales revenue after deducting all expenses, including taxes.
The easiest way to think of it is all sales less variable* costs less fixed costs.
(* variable costs are sometimes called direct costs, see “The economics of sunflower production” in this series for more detail [link to 1st article])
Fundamentally, profit is a measure of how efficient your business is, how well are you using the resources of the business, and are you getting the best return on your capital?
Understanding how cash and profit affect the business, and how we can measure them, will allow us to manage a more efficient and sustainable farming enterprise.
While cash and profit are not the same things, you do need both to sustain and grow the business, and they are equally important in ensuring long-term success.
You cannot have one without the other, at least not for long.