November 15, 2021
Few businesses are continuously profitable year after year. In fact, according to the publication Small Business Trends, only 40 percent of small businesses turn a profit, on average.
After years of working with entrepreneurs — especially those in agriculture — we can confidently say that one of the key predictors of profitability is knowing how much cash is coming in and going out of the business. Seems simple, doesn’t it? Yet, for many business owners, that information is just out of grasp.
That’s where a cash flow projection becomes essential. If done consistently, a cash flow projection can help an owner make vital decisions that will increase the longevity and profitability of their business.
Here are the basics every owner should consider.
What a Cash Flow Projection Can Do
A cash flow projection estimates the amount of cash that will flow in and out of a business, including income, expenses, and other balance sheet items like investments and debt. This type of projection can help predict whether a company will experience a cash deficit or surplus during any given period throughout the year.
Main Components of a Projection
At Grimbleby Coleman, we tailor our projections for each business. With this in mind, generally, a cash flow projection takes into account:
- Sales: This includes any new customers or contracts that will increase both sales and variable expenses (related to sales or production) or any loss of customers or contracts. We also consider the market price of the product the company sells when creating projections.
- Expenses: Labor wages, fringe benefits, and the cost of enforcing regulations are some of the largest expenses that businesses manage. Therefore, any change in these factors, such as a minimum wage increase, will significantly affect a projection.
- Cost of Goods Sold (COGS): COGS include the direct cost of producing goods, such as raw materials and packaging. This can vary wildly, especially when the economy is experiencing supply chain issues and inflation. We look at the estimated market prices of raw materials and the cost of production to cover consumer demand. Even a small increase of 2 to 3 percent can dramatically impact on the bottom line of a business.
- Investments: It’s essential to include any investments that may improve efficiencies or capacity, as well as the direct effect those investments may have on other expenses such as sales, labor, repairs, or taxes.
- Debt: Debt must be paid monthly and should be considered a recurring expense. Agriculture clients often have complex debt that should be given special consideration. For example, if a farmer is developing a new orchard, the loan used to finance that orchard may be used to offset development costs or purchase new equipment that will pay off in reduced labor in the long run. Many farm lenders will offer money for developing orchards and charge interest on a monthly basis. When the orchard is fully developed, the farmer will then begin making payments toward the principal — an increase that can and should be anticipated.
Cash Flow Projections Are Especially Important for Ag Businesses
Ag is seasonal by nature and poses its own set of considerations. Most ag businesses operate without any cash flow for nine months of the year. Then, once the crops are harvested and sold, the payment waiting game begins. That makes the big picture especially important for farmers and others in ag: monthly wages, taxes, and debt can’t wait for the three months of a year when the profits roll in. A cash flow projection can help an owner determine if a loan or line of credit will be needed.
Farmers should pay attention to the long game, as well. Orchards usually don’t turn a profit for at least five years. Planning for gaps in income can help businesses stay on solid ground.
We often consider these additional factors when discussing projections with our ag clients:
- We recommend pre-payments, when possible, but it’s equally important to know if a business will be able to make only one balloon payment instead.
- Deductions: Small businesses that take in less than $25,000,000 in gross revenues may be allowed to deduct (rather than capitalize) their development costs and expenses — for example, tearing down old orchards and the cost of bringing along new orchards. We generally recommend growers take the current deduction rather than waiting for future depreciation benefits.
- Environmental and outside factors: This year, ag clients are experiencing the double crises of drought and supply chain bottlenecks. To adjust, we have been building projections based on normal years and then making predictions that anticipate several different scenarios. Market prices and yields can be challenging to estimate in January, so it’s helpful to tweak projections throughout the year based on new information. In addition, many handlers export their products overseas, which may help growers receive their payouts, but port slowdowns and stoppages can severely impact the timing of that cash inflow.
A professional cash flow projection can help business owners anticipate bumps in the road and take advantage of opportunities. At Grimbleby Coleman, you can count on us to build a projection schedule that’s right for you and your business’ needs. With the investment of a little time, you can head off headaches and begin building stability for the long run. Contact your accountant or send us an email at firstname.lastname@example.org to find out how we can help.