Dairylink: budget cash regardless of milk price

The financial situation on most dairy farms at the start of this winter is significantly different to what is was this time last year.

Improved milk prices mean some farmers find themselves with surplus cash to invest in their farm businesses or set aside for the next trough in the dairy market cycle. However, a lot of farmers are not at this stage yet and are using additional cash to repay creditors, overdrafts or bank loans taken out in 2015 or 2016.

Although availability of cash is less of an issue than it was 12 months ago, preparing a cashflow budget is still a useful exercise to allow early plans to be made for future cash shortages or the timing of capital expenditure.

A cashflow budget is a projection of the money coming into and out of the farm business, and the subsequent bank balance, each month for the next year.

It is useful to develop a cashflow budget on autumn-calving herds at this time of the year as the cost of production is increasing as the weeks progress. However, spring-calving herds will also benefit from the exercise, especially for the months cows are dry and income is at an annual low.

Receipts and expenses

On Dairylink Ireland programme farms, the most significant receipts include sales of milk, calves, cull cows, surplus heifers and CAP payments. Expenses on project farms include concentrates, fertiliser and lime, drawings, veterinary bills, contractor bills, electricity, water, machinery and loan repayments.

It is important to include all income and expenses in a cashflow budget and to use realistic estimates of figures that are not known at present. A cashflow budget is only as good as the information used to develop it.

Most farmers have all business receipts and costs coming in and going out of a single current account.

This leads some to argue that a cashflow budget is not needed as the current account balance gives an accurate indication of the financial situation.

However, the bank balance only gives an indication at a point in time and the information is historic. A cashflow budget lets you see future peaks and troughs in cash reserves and allows time for forward planning.

Farmer A

Over the past 12 months, Farmer A has expanded his dairy herd by purchasing 20 in calf heifers at £1,500 per head. There has also been investment in grazing infrastructure with £20,000 spent on new laneways, fencing and drinkers.

This year’s total capital expenditure of £50,000 was paid for from cash reserves in the current account. The balance in the current account is now £2,500 and there is no other bank account, although an overdraft up to £50,000 is available on the current account at present.

Case study example

Farmer B

Building an extension to a shed and new slurry tank, purchasing 10 in-calf heifers and changing the telehandler meant Farmer B spent £50,000 in capital expenses this year.

At the start of the year, he took out a £50,000 loan to be paid back at 5.5% interest rate over 60 monthly repayments. The three investments were paid for by the bank loan and around £11,500 is paid back each year meaning the loan costs around £7,500 over the five-year period. His current account balance is £37,000.

Keeping cash in the bank

Although no one knows when the next downturn in milk prices will occur, how low prices will go and how long it will last for, it is still important to be prepared for an income shortfall.

Setting up a second bank account to hold surplus cash can allow a more disciplined approach to build up savings and avoid spending cash reserves. A direct debit can be set up to let this happen automatically and cash can be moved back to the current account if needed.

If capital investments are paid for by cash from the current account, then cash reserves are significantly lowered, as the example of Farmer A illustrates. This can later lead to dependence on an overdraft to address an income shortfall, which can be difficult to pay back in a milk price downturn.

A better approach, as illustrated by the example of Farmer B, is to pay for investments with a short-term loan from the bank. This allows cash reserves to remain available for use in the future.

It also allows a structured repayment plan as the timing and size of loan repayments are known. Some loan arrangements will be flexible and will allow early repayments if cash reserves continue to build up, or will allow repayments to go interest only during a downturn in milk prices.

Most bank managers would rather have customers present a cashflow plan and ask for a short-term loan to invest in their business, than only have contact with customers when there is an income deficit and an overdraft extension or interest only repayment on a loan is needed to keep the business operating.

In the case study examples outlined, it may seem that Farmer A has saved £7,500 over five years by not having interest to pay on a loan.

However, if Farmer A finds himself requiring an overdraft then interest rates apply which are sometimes significantly higher than the rates charged on short-term loans.