Friday, March 29, 2024

Using the numbers to build a picture

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Much has been said about the importance of budgeting, cashflows and monitoring this season – but what does that really mean for a farming business? Why should you track the variances or differences between predicted and actual cashflow? How do you establish if a variance will have a positive or negative effect on your business? Or is there even any value in tracking and charging how you spend money through the season compared with just letting things run till the end?
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First, let’s establish the role each financial management tool plays within a business. 

Annual budgets detail expected cash received and expenses going out. It is an essential component in establishing the financial viability and long-term stability of a business. It is the financial plan of action which underpins the long-term business strategy. However, it fails to outline the ability to meet cash requirements on an ongoing basis. 

For most businesses there is a lag phase between when cash is spent in the production of a product and when cash is received for sale of the product. It is these gaps in income and expenditure which could expose the business to cash shortfalls and an inability to pay bills as they arise during the year. 

Hence the importance of having an annual cashflow budget, which DairyNZ defines as a financial budget showing expected income, expenses, the resulting surplus or deficit and bank balance over a given period. 

Having predicted the overall income and expenditure alongside the expected timing of each, the focus should shift to ensuring the financial targets are achieved by tracking and monitoring progress between predicted and actual annual cashflow budget. The difference between budgeted figures and actual figures is termed a variance. 

Variances can be either positive-favourable (better than expected) or negative-unfavourable (worse than expected). Variations should be expected when comparing a predicted scenario with the actual event. A variance report is an important management tool because it highlights areas of business performance that aren’t in line with expectations, and whether the difference is favourable or unfavourable.  

However, it is important to note the information presented in a variance report is not an overall indication of business performance. It is a snapshot of how the business is tracking towards its end goal. It’s equally important to note that not all variations are created equal and only provide part of the picture. For example, an overspend like spending extra on animal feed this spring doesn’t reflect the tactical decision to purchase feed earlier than planned or budgeted for in the season, to take advantage of a reduced market rate for feed which would save the business money in the long-term. 

Similarly an underspend in predicted nitrogen expenditure in spring or winter doesn’t reflect the re-arrangement of annual nitrogen applications throughout the season in favour of applying more during periods of increased response rates. The overall cost of nitrogen application is the same but the timing of the costs has varied. Regardless of the reason behind a variance, it’s critical the predicted cashflow is updated to ensure additional or deferred spending at a certain time doesn’t overly stretch the cashflow position and balance sheet. 

The challenge for a farming business is to establish the potential impact variances might have for current cashflow and overall financial position. To do this, a business must be continuously updating its predicted cashflows and exploring potential responses to variations.

Monitoring and analysing the effect of a variance is key to tracking the business’s overall financial position. This is a valuable tool to assist in making proactive decisions on actual and recent data. This should form the basis for open communication between the actual and predicted financial position during the year. 

Tracking the variances between predicted budget and actual budget can help diagnose potential issues early around the financial health of the business. Through a combination of regularly reviewing variance reports, updating cashflows and monitoring predicted annual budgets, farmers are empowered to make real-time decisions on how income, expenditure and projected cashflow should be managed for the remainder of the season. Early identification combined with a clear understanding of updated cashflow can provide insight into:

  • the short-term financial position and how this will impact on the long-term goals;
  • any operational issues;
  • if the implementation of the proposed long-term strategies, as expressed through the annual budget, is on track; and 
  • if there is a need to re-evaluate or update the long-term business forecasts. 

This kind of financial insight is essential during the current environment of instability. It helps ensure variations between predicted and actual spending is reviewed and analysed for short-term and long-term effects on the business and provide a realistic outlook for long-term business strategies during periods of volatility. 

Early diagnosis helps the business act quicker to either maximise profit by taking advantage of opportunities or minimise losses by changing practices in current spending habits to improve the long-term outlook for the business.

With clarity on the current financial picture early, it’s possible to share the information early with the accountant and banker, front-foot conversations and have a no-surprises strategy in place, which is sure to please everyone. 

Banks like to feel their clients have a strong understanding and are in control of their business. It is important they trust your management and know if things aren’t going well temporarily you will be proactive and address it with confidence and a plan. By having the discipline of regularly spending a little time reviewing where the money goes, there’s a good opportunity to challenge yourself about the mix of inputs you are buying and the farm system you are running.

The process is best described as a review of the Plan, Actual, Difference, Impact and Strategy or PADIS, which was recently outlined at a Dairy Women’s Network event Tracking Your Cash. This simple five-step process is outlined in Table 1. It challenges farmers to go further than the standard variance report of establishing the difference between predicted and actual budgets to review the impact variations will have on cashflow, annual budgets and how this will impact the business’s current and long-term financial position.

The 2015-16 season will be tough, with most farmers operating at a loss. 

The challenge is to not bury your head in the sand and accept the loss, but be proactive with monitoring and reviewing cashflow along with updating annual budgets to predict the variance between predicted and actual annual budgets to get a greater understanding of what is happening in your business.

These financial tools can create a powerful picture for a farm, to help you be proactive in sharing information with key rural professionals, and make informed timely decisions on your future.

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