Creating a financial plan can be a complex process. You may need additional spreadsheets to assemble information and budget totals. For help and examples visit Maryland Rural Enterprise Development Center.
The income and cash flow statements are used to make projections. Projections are a businesses’ best estimate of income and expenses over a period of time. Being conservative and realistic with your projections will help your business in the long run.
The best way to start making any projections is to review your enterprise budgets and financial statements. From there you will be able to predict average costs and expenses over time. Your implementation strategy and sales projections should be reflected in the pro forma financial statement.
Financial Statements help you:
- Determine your farm’s solvency, profitability and liquidity
- Make important production, financing, and investment decisions
- Help with credit and lending applications
- Develop budgets for farm enterprises
Along with projections your farm may also want to conduct financial ratio analysis. This will look, long term, at projections and costs and answer questions regarding liquidity, profitability, and debt.
The financial position and performance of a farm can be described with three financial statements. These statements are generated by organizing and analyzing your business’s accounting activities. While financial statements take some research and homework, they are very beneficial to your farm business.
The three financial statements show different financial measures for a business.
The balance sheet is formatted with assets on the left hand side and liabilities and net worth on the right hand side.
- Assets—are items owned by the farm business, such as land, buildings, machinery, livestock, crops in storage, and supplies.
- Liabilities—are the debts owed by the farm business, such as notes payable, interest, taxes, loans and rent.
Farm assets and liabilities are divided into three categories according to their length of life, cash liquidity, and effect on production in the farm business. The categories are current, intermediate, and long term. A fourth category lists non-farm assets.
When estimating asset value there are two possible methods: Market Value or Cost Approach.
- Market Value: values assets at the estimated current market value.
- Cost Approach: values assets at their original cost plus cost of improvements minus depreciation.
Net Worth is sometimes referred to as owner’s equity. It is the difference between the value of farm assets and the liabilities against those assets.
Projected Income Statement
A projected income statement, sometimes called the projected profit and loss statement, is developed to forecast farm profitability. It estimates future income, expenses, and profit for the business. The projected income statement will cover a given accounting period such as a calendar year or other fiscal period.
Projecting an income statement is made easier if there are historical income statements to use as a reference point. Another aid in projecting an income statement is the enterprise budgets. Enterprise budgets estimate income and expenses on a per unit bases. Taking the various enterprise budgets for the business and multiplying the income and expenses by their respective total number of units in the business and then adding them together will approximate the projected income statement.
During start up and transition periods some businesses will need to develop projected income statements over several years. Long-term projections are especially important for businesses that will have escalating sales volume over multiple years, large inventory differences from year to year such as perennial crops or nonperishable goods and businesses with enterprises starting on different years.
Cash Farm Income - List sources and values of your cash farm income. Include revenues from sales of crops, livestock, livestock products, and government payments from commodity programs. Also include income received for custom work, co-op dividends, and others.
Cash Operating Expenses - Include those expenses associated with the operation of the farm business. In addition to variable production expenses such as feed, seed, fertilizer, short-term interest on operation capital and supplies, include fixed cash expenses such as taxes, insurance, and interest on intermediate and long-term loans.
Depreciation - Even though depreciation is not a cash cost to the operation, it should be included in the income statement because it represents the loss in value of buildings, machinery, and other assets that wear out as a result of production. Without it, the income statement will not account for these economic losses. Historical depreciation can be a starting point for estimating future depreciation, but you must also consider the depreciation for future machinery and building purchases that are included in the business plan. A simple way to estimate the annual depreciation is to take the purchase price (beginning value) of the equipment and buildings, subtract out the salvage value (ending value) that will exist at the end its life and divide by the number of years of useful life.
Profit or Loss - The projected income statement should give a picture of future business profit. As the business changes there is often a transition period where profits may vary year to year. If this is the case, you may want to develop and projected income statement for each year until the business reaches a steady state. As your plans progress you will want to have a good accounting system in order to construct historical income statements to analyze the progress of your business.
Cash Flow Budget
Another important financial statement is the cash flow budget. This budget estimates the flow of money in and out of the business. It is similar to the projected income statement in that it estimates the cash income and cash expenses. However, there are important differences. The cash flow budget does not include depreciation since this is not a cash expenses. Rather it will include the actual purchase prices for capital purchases - machinery and buildings. It will include sales of capital assets. It will include cash flowing into the business from loans including loans for machinery and buildings. It will also include loan principal payments. It includes other receipts from non-farm sources as well as withdrawals from the business.
The cash flow budget estimates the timing and size of cash inflows and outflows that occur over a given accounting period, normally one year. The period is broken down into smaller time periods such as quarters or months. Think of the cash flow budget as a checkbook for the farm with an accounting of deposits and withdrawals. Here is an explanation of these.
- Crops and livestock sales—these are the primary source of cash for your farm business and are critical to maintain the liquidity reserve.
- Other farm receipts—this includes payments from government programs, custom work, and co-op dividends.
- Non-farm receipts—include items such as income from an off-farm job, savings, investments, interest earned and capital.
- Capital sales—includes the sporadic cash inflows from the sale of land, buildings, machinery, breeding livestock, and tools.
- Borrowed money—is considered a residual source of cash used to maintain your liquidity reserve when cash outflows exceed the sometimes sporadic inflow.
- Production expenses—are a large draw on your liquidity reserve. They include seed, feed, fertilizer, chemicals, hired labor, and repairs.
- Capital expenditures—include cash outlays for replacing and adding machinery, breeding livestock, land, and buildings. These are important to your farm but should be planned with care.
- Loan payments—are payments on borrowed money. Consider this when formulating your loan payment schedules and the seasonality of your farm business.
- Family living expenditures or withdrawal—are sometimes overlooked as being secondary to the other cash outflows
The cash flow budget is projected at the beginning of the year to forecast the inflows and outflows and estimate the ending cash balance for each quarter or month. As the year progresses, keep an actual cash flow statement to record cash transactions as they take place. Then compare the actual cash flow statement with the projected cash flow statement to see if things are going as planned, to devise remedies for previously unforeseen problems, or to take advantage of opportunities not anticipated. At the end of the year, use the actual cash flow statement to estimate the projected cash flow for the next year. This is especially important for agricultural businesses because of production cycles and the seasonality of the business.