Farmers need to understand cash flow projections, appreciate its importance and, ultimately, learn to draw them. This gives them control over their finances and future, argues Maluta Netshaulu, a leading agricultural economist and banker.
The early stages of my career were spent on compiling comprehensive viability reports evaluating and assessing a farming operation’s worthiness to raise debt funding. The report was structured into four components coined “the four legs of the tiger” – the jockey or operator, financial position, repayment ability, and security.
These components are crucial in determining whether a farmer possesses the right behaviours and has a business that can afford to repay a loan, whilst also not putting the business under pressure by over-gearing it.
Although it is important to unpack these components, for the purposes of this article I would like to focus on just one: repayment ability. We will indirectly touch on the importance of the other components as they are all interdependent.
The fact that not all farmers understand cash flow projections nor know how to draw them, is not commonly mentioned in the agriculture sector. But it is a reality. I remember going to farmers’ premises with my laptop to complete a projection template along with the farmer.
First, we would talk about their plans for the upcoming season in terms of what they plan to produce, how much they plan to make in income across their produce, and by when they should be receiving the income. I would then plot this on the top part of the Excel document.
Counting the cost
Once we were done with the income part, we would move to the expenses. Here, we would start with direct expenses directly linked to production. If production increased, other things being equal, the cost of production would go up, and vice versa.
Items that would fall into this category were input costs like seed, fertiliser, lime, pesticides, weedicides, diesel, crop insurance, hedging, and maintenance. It wasn’t as easy as saying, “Farmer, how many seeds did you buy for this season?” and then inputting whatever figure the farmer gave me.
Figures had to be inputted on a per-hectare basis per line item and the model would then calculate the total cost depending on the number of hectares the farmer planted per produce. For example, if the farmer planted 200 hectares of white maize, the projected income would be the expected price per tonne multiplied by the projected yield per hectare (in tonnages), and they multiply by the total hectarage (the 200 hectares) planted.
This would be on the top section of the cash flow projection. And then on the direct costs side, I would put in all the inputs that the farmer needed to buy and apply to achieve the projected income.
If we can just focus on the one line item, seed, the farmer would say the seed was bought from company X for X amount. The farmer would calculate how many kilograms of seed were required per hectare and then the farmer would the use his pocket calculator or phone to calculate the cost per hectare.
This is the cost I would then put in my model which would then spit out the total seed cost for planting 200 hectares, which I would then plot on the month the farmer bought the seed. We would then perform this exercise for all the direct costs.
After direct costs, we would move to indirect costs – costs that are not linked to production, but are necessary to run the operation like security, bookkeeping, admin, life insurance, telephone contracts, etc.
What about debt repayments?
The next step would be to look at the debts repayment section.
Here the farmer would provide all the debt their operation currently has, including vehicle and asset finance for all machinery and equipment, and term loans for properties that are still under finance. The farmer would provide the associated repayments for each debt line item. Farmers, in general, with the exception of those in animal and vegetable production, pay their debt obligations annually and aligned with the periods or months in which they received their income.
So, once I had all this information and plotted the amounts in the cash flow model, the model would then show the margin, i.e. net surplus which is gross income less total expenses (direct costs plus indirect costs plus debt repayments). Ideally, you want this amount to be positive, because if it is negative, the regulation stipulates that providing (additional) lending to that farmer would be tantamount to reckless lending.
Depending on how much the farmer has in their bank account, the model would also show the bank account fluctuations.
Where the monthly closing balance was negative, that would be reflecting how much of an overdraft the farmer would require to keep the operation running until income starts to flow into the operation.
The above is the simplest way I can explain how a cash flow projection is populated. The information required to do so, its importance and impact when done well.
So, why do farmers of all sizes need to understand cash flow projections, appreciate their importance, and ultimately learn to draw them? The simple answer is that it gives them control – control over their finances, and control over their future.
Keeping up to date with your operation
Back when I was still an agricultural advisor, there were many times that farmers would say they would ask their bookkeepers for information, or we must go to their bookkeepers to get that information because they don’t know.
I believe this should be a red flag, especially for a small- to medium-sized farming operation where only one person is in charge and should know these things. For large family farming operations, it is understandable as by sheer scale of their operations they have people like financial managers and accountants that are part of the businesses, and whose responsibility it is to provide financial institutions with these types of information and documents.
You will remember that I said understanding repayment ability is important as it indirectly speaks to other components namely jockey, financial position, and security. In order to understand repayment ability and also be able to draw up a cash flow projection for a farming operation (or any business for that matter), the owner needs to:
- have discipline and integrity;
- needs to know what is happening in the operation;
- what is happening in the macro environment (with the market and prices etc.);
- what is the financial health of the business in terms of the level of gearing (debt vs. equity), and whether it is still within acceptable levels;
- have a view of how the operation performed in previous seasons and what can be done differently;
- whether the operation has adequate security and capacity to raise capital.
All farmers – especially those that are still considered small and up-and-coming – should learn how to budget, which will go a long way to build their capacity (and give them control of their destiny), ultimately making them bankable or within the risk parameters of financial institutions.
It will not be an easy road, but what I know is that financial institutions, industry bodies, commodity associations and government (together with their agencies and provincial departments) have programmes in place to help small and medium enterprises, like farmers, to develop this important skill as part of their financial literacy programmes.
- Maluta Netshaulu is an agricultural economist, banker, husband and a father. The views and opinions expressed in this article are those of the author and do not necessarily reflect the views or positions of Food For Mzansi.
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