THE IMPORTANCE OF INCLUDING ‘WHAT-IFS’ IN THE BUDGETING PROCESS
By Wendy Santoro
By Wendy Santoro
The key is to prepare projections with the ability to allow flexibility and constant updates for changing factors. What if the price of fuel increases by 10 per cent or production yields decrease by 10 per cent from what was expected?
Everyone knows “Cash is King.” So, how come so few of us take the initiative to protect our kingdom?
The market for farming is volatile. A farmer constantly faces changing prices, increasing costs and increasing competition from the global market. A farm today requires innovation and technology in order to maximize yields and revenue.
A crop yielding a high price today may not always be next year’s crop to plant. In fact, tomorrow’s profitable crop is sometimes based on uncontrollable conditions. For example, a drought in one area causing devastation to one farming region may create opportunities for those farms not affected by the drought.
Other factors, such as disease, may reduce yields. Exchange rates, pricing and climbing costs all affect profits and cash flow. The key is to be able to monitor the key factors to determine their effect and control the outcome, rather than letting the outcome control the viability of the farm.
Although some of these conditions may not be controllable, a well-managed business is better able to manage controllable factors, predict problems and act on them. Many successful companies rely on budgets, including cash flow forecasts and projections in order to predict not only profitability but also cash availability.
When planning for the upcoming crop year, it is as important to forecast the cash requirements as it is to project profitability. While profit is a vital indicator of the performance of a business, generation of profit does not necessarily guarantee a company’s future development, or even survival. A business may be profitable on paper, but without the appropriate level of cash flow and reinvestment in the business, it will stagnate and be unable to grow.
Farming is no exception. In fact, due to the often large upfront cash outputs for expenses, including labour and raw material input costs, a farm is frequently in a negative cash position until the product is sold and collections are received. This makes it imperative for the operation to understand its costs, pricing and their effect not only on profit but also on cash requirements.
The volatility of the market is the reason to prepare a budget including a cash flow projection. The key is to prepare projections with the ability to allow flexibility and constant updates for changing factors so that the projections are usable. Profit projections and comparison to actual results help to maintain control over manageable costs whereas cash flow projections help to manage cash requirements. Flexible budgets are an important forecasting tool and can be utilized in order to predict changes to profitability and cash flow crunches when variables in the market change.
Flexible budgets allow the user to answer “what if” questions. For example, what if the price of fuel increases by 10 per cent or production yields decrease by 10 per cent from what was expected. What’s the effect on profit?
More importantly in the short run, what does this mean to cash needs? Will there be enough cash to make it through the harvest or do arrangements need to be made to provide other sources of funds in order to make it through the difficult period?
The earlier you are able to identify that there is a problem, the sooner you can begin working on the solution to protect the kingdom.
Wendy Santoro is a senior manager with the financial advisory group in the Windsor Office of Deloitte.
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