William Edwards                                            Revised November 2004                 Iowa State Extension Economist 478C Heady 515.294.6161 wedwards@iastate.edu

A cash flow budget only indicates whether or not the farm business will produce enough cash income to meet all demands for cash. It does not estimate net income or profit. In the example outlined in Cash Flow Budgeting for a Value-Added Farm Business, the farm business will be short of cash by $22,686 for the year as a whole. However, the projected cash outflow includes:

• $36,000 for family living expenditures
• $32,746 for repayment of borrowed funds
• $50,000 for trading combines

Remember that net farm income also includes non-cash items such as depreciation and changes in crop and livestock inventories, and that net farm income can be very favorable even when net cash flow is negative.

The first step in analyzing cash flow is to add cash on hand to net cash flow. If total projected net cash flow for the year is still negative, annual adjustments that can be made include:

• Sell more current assets (crops and livestock). Be careful here, though—reducing inventories may solve the cash flow squeeze this year, but result in even more severe problems next year. 
• Finance capital expenditures with credit, or postpone them until another year. 
• Try to reduce the size of intermediate and long-term debt payments by lengthening the repayment period or adding a balloon payment at the end. 
• Convert short-term debt to intermediate or long-term debt by refinancing. 
• Reduce non-farm expenditures or increase non-farm income. 
• Sell intermediate or long-term assets.

In the example in Cash Flow Budgeting for a Value-Added Farm Business, financing 50 percent of the $50,000 combine trade with a lender ($25,000) would leave a positive net cash flow for the year of only $2,314. The $25,000 is entered as new borrowing in the period when the purchase was projected (July through August).

Even when the yearly net cash flow is positive, sizable deficits can occur in certain periods. This is due to the seasonal nature of expenses in farming and the tendency to sell large quantities of a product at once. Some types of enterprises, such as dairy, produce a more constant cash flow than other types.

Seasonal adjustments that can be made when projected net cash flow is positive for the whole year but negative for some periods include:

• Shift the timing of some sales.
• Shift the timing of some expenditures.
• Increase short-term borrowing in periods with negative cash flow with repayment projected in periods with positive cash flow. Don't forget to add interest charges to payments.
• Delay due date of fixed debt payments to periods with positive net cash flows.

In Example 4 of Cash Flow Budgeting for a Value-Added Farm Business, cash on hand at the beginning of the year is $6,146. Enter this in the January-February column. Then work through the remaining periods to determine the amount of additional new borrowing needed in each period.

The farmer in the example wishes to plan for a cash balance of at least $1,000 at the end of each period. The cash flow can be balanced by planning to borrow $38,567 in operating capital in April, $49,129 in July and $52,121 during November and December. The $50,221 increase in loan balance ($253,421 - $203,200) was due to the operating loss of $22,686 and the payment of $27,535 of interest on the operating loan.

Some farmers operate with a line of credit from their lender, with a maximum borrowing limit, instead of borrowing funds in fixed amounts. The cash flow budget can also be used to test if the need for operating capital will exceed this limit, as shown in the lower part of Example 4 in Cash Flow Budgeting for a Value-Added Farm Business.

• Add the outstanding balance on the line of credit at the beginning of each period to the amount of new borrowing in that period. Then subtract the amount of principal to be repaid to arrive at the ending credit balance for that period. Do not include new borrowing to be repaid over several years (such as for the combine) if the borrowing limit applies only to short-term capital.
• In this case we are concerned only with the amount of principal borrowed and repaid.
• In the example, the farmer started the year with an annual operating loan balance of $203,200. The loan balance dropped to $147,575 at the end of March but increased to $253,421 by the end of the year.
• If the projected ending credit balance for any period exceeds the credit limit, adjustments to cash flow can be made as discussed above.

Review your cash flow budget from time to time during the year. Prices and costs may have been different from your estimates, or production plans may have changed. 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.

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.

Budgeting major investments or changes in the farm business

A cash flow budget can also be very helpful in evaluating major capital investments or changes in the farm business. Examples are purchasing land, building new hog facilities, or expanding a beef cow herd. Often it will be necessary to develop two budgets: one for a business year after the investment or change in the business is complete, and one for the intermediate or transition year (or years).

As an example, a beef cow-calf producer decides to expand the herd by holding back heifer calves. The producer should develop a total cash flow budget for the operation as it will be after the expansion is complete. However, the greatest cash flow problem may be in the transition year. The expenses will increase because there will be more cattle in the herd but income will be down because fewer heifer calves will be sold.

Expansion of a livestock enterprise through construction of new facilities can often create cash flow problems in the construction year, even if the facilities are financed with an intermediate or long-term loan. This is especially true if it will take some time to expand the enterprise up to the capacity of the facility.

As an example, a dairy producer builds a new facility with capacity for 50 cows. Currently there are 35 cows in the herd. It will take the enterprise two years to expand the herd to 50 cows by holding back its own heifers. In the meantime, the producer will have to meet the loan payments on the facility, while the sale of young heifers and cull cows will be reduced. An alternative might be to buy the 15 additional cows and expand production immediately. Then the producer would have to repay the loan on the purchased cows. A set of cash flow budgets could help select the best alternative in terms of financial feasibility.

* Adapted from Ag Decision Maker, Iowa State University Extension “Analyzing a Cash Flow Statement”,   www.extension.iastate.edu/agdm