One key point to remember when starting out is that the ability to generate short term positive cash flow does not guarantee long term survival.
Cash Flow, Net Worth, and Profit
Cash Flow tracks the cash dollars into and out of the farm. You should be able to balance where all of the money came from and went to.
Start-up investment + Cash from operations + Borrowed money =
Cash paid for expenses + Debt payments + Money left at end of year
Sometimes cash flow expenses will be particularly high in the spring as crops are planted and income will be high in the fall when crops are sold. Therefore, cash flow also takes on a role in planning and savings to be sure you can cover future needs.
Cash flow records make sure you can keep track of your money, pay your bills in a timely manner, and are crucial to long term profitability
Net Worth tracks your investments in the farm. It is also called the Balance Sheet (.DOC). It is:
- Everything the business OWNS minus everything it OWES = Net Worth
- Assets You Manage – What you Owe = Your Ownership
- Assets – Liability = Equity
Some assets go up in value over time such as land. This is called appreciation. Some assets go down in value over time such as equipment. This is called depreciation. Depreciation is a measure of the wear, tear, and obsolescence of an investment.
A balance sheet is a critical part of a Business Plan. It is a very useful tool for you to track, over time, if your net worth is increasing. If you are making smart investments in your business, it should be! From a bank’s perspective the primary function of net worth calculations are to measure your financial solvency and ability to bear risk. (How much you really own and how much does the bank own)
Profit: If your business is profitable, you will see this reflected in your Net Worth. If the difference between assets and liabilities is not increasing in a positive direction over time, you are not profitable. You can download a free blank template for a Balance Sheet here (.DOC)
You may have very good cash flow from month to month, but low profitability. Or the reverse, where you have high profits but poor cash flow. Here are a few examples of both scenarios:
Some examples of Good Cash Flow, but Low Profitability:
- Living off of inventories or depreciation, and not reinvesting in the operation
- Outside income or off farm jobs that help reduce need for family living withdrawals
- Borrowing money
- Not paying bills
Some examples of Bad Cash Flow, but Good Profitability:
- An expanding business with increasing assets, but few cash sales
- High withdrawals for family living (ex college expenses)
- Paying down debt rapidly
- Buying next year’s assets from this years cash (ex prepay on fertilizer)
- Increase in accounts receivable (have not been paid for assets that were sold).
As a farm manager, one of your jobs is to anticipate cash flow needs, and to monitor profitability for each enterprise and across the farm as a whole, at least annually.