University of Maryland Extension

Summary

Author: 
Dale M. Johnson, Extension Specialist, Farm Management

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Understand profit and cash flow is paramount to the success of the business. Profitability measures the amount of farm income generated from sales of goods and services over and above the expenses required to generate that income. An income statement is used to analyze profitability. A farm must generate a profit to survive in the long run. In calculating profit, farm managers often leave out expenses related to the value of their labor, management and investment. Not only must farm income cover the direct expenses of the business, but they also must cover these resources that are sometimes taken for granted.

Cash flow relates the ability to meet cash obligations without disrupting the normal operation of the farm. It deals with the timing of cash inflows to meet the cash outflows. Cash receipts from crops and livestock sold rarely coincide with cash expenditures. A cash flow budget is used to analyze the timing of cash inflows and outflows. Most farms have periods when they are short of cash to pay bills. A credit reserve for borrowing money through these periods is needed to maintain the cash flow. Likewise, this money will have to be paid back. Cash flow planning helps to monitor these inflows and outflows. Profit and cash flow are both areas of concern for the farm manager.

The operation that is strong in one of these areas is often strong in the other areas as well. Profitability drives cash flow. A profitable farm will usually overcome cash flow in the long run, while an unprofitable farm will nearly always develop cash flow problems. People often confuse profitability with cash flow and vice versa. Some farm managers who experience cash flow problems think that their farm is not generating any profit. Likewise, some farm managers who have a positive cash flow have the impression that their operation is profitable. Neither of these assumptions is necessarily true. You cannot equate profits with cash flow.

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