Planning for the financial success of your farm is not just wishful thinking. It is necessary for the farm’s success. Andy Radlin, University of Rhode Island Cooperative Extension agent, and Josh Daly, Rhode Island Small Business Development Center representative, recently presented a webinar on the subject, “Farm Business Planning and Budgeting.”
Daly recommends that farms develop a one-page visual tool to map essential farm functions, including production/operations (creating value), sales and marketing (delivering value), financials (capturing value) and something called FOCUS (financial, operational, customer and “us,” the team).
The visual tool and budgeting “go hand in hand,” Daly said. “The thing is to make sure your business plan and financial plan talk to each other. They should integrate and make sense.”
He believes that FOCUS is a good tool to visually represent the business operations as they exist as well as show how a farmer wants them to be.
He likes the business tools from Farm Credit East and said that the organization “has a lot of good resources.”
“Having it as a one-page plan allows it to not be a 50-page thing that sits up on a shelf you never look at again,” Daly said.
He explained that a business plan should be about knowing the business, using FOCUS to guide actions, not creating something that is not used, planning something that does not work, or using financial jargon that makes no sense to the users.
“Do the research you need to do, so you know it’s not ‘wishes and hopes’ about what the market may be like, but it’s rooted in reality,” Daly said.
Diving Into the Finances
Creating the one-page budget plan/financial plan begins with last year’s records.
“If you’re starting new with a farm, we can help with industry information and templates,” Daly said about getting free help from a Small Business Development Center. “Obviously, it’s not as easy to budget for a new operation. You don’t have prior years to go off of. We can make sure you start someplace relatively reasonable. As you’re doing this, you may need to take stock of how good your recordkeeping is. How do you keep them?”
Radlin advised, “Keep it closely connected with the recordkeeping of your inputs in your farming operation.”
Daly likes to tie financial and non-financial information together, which can help associate costs with the value of farm products made. Excel spreadsheets or software, like Quickbooks, may help.
A five-line income statement, also called a “profit and loss” or “P&L,” is a basic record of sales, minus the cost of goods to equal the gross margin. Subtract from that figure the overhead costs to get the net income.
“This is a basic record over a period of time, like a year, or you could do it over a different period of time, if that makes sense for you,” Daly said.
The cost of goods sold, or “COGS,” is any expense that helps produce one more unit of output. These could include seed, soil, fertilizer and labor, for example.
“COGS directly goes into a unit of what you’re going to sell,” Daly said.
“Overhead” is any expense a farm has, regardless of production levels, such as salaries of office staff, repairs, supplies, marketing, utilities, insurance, interest, taxes and depreciation. Capital and equipment expenditures are not included.
The five-line income statement can show what percentage of sales goes to COGS, gross margin, overhead and net income.
“The important thing about this is (to be able to) compare year to year, season to season, month to month,” Daly said. “I can compare to the industry better through percentages than the raw dollar amounts.”
If a farmer can improve their level of production without spending more, that can improve the gross margin, which generally improves the net income.
Farmers can also break down the various revenue streams and COGS for each farm product. That can help determine which areas of the farm truly make the most money, rather than what brings in more gross income.
“Can you add additional revenue streams, bundle products, or add value without having expenses go up at the same time?” Daly said it’s important to ask yourself. “Can I diversify my revenue, so it’s coming in different ways regularly?”
Breaking down sales of like items by sales channels can also help. For example, calculate tomatoes sold at the farmers market, to restaurants and to schools.
“You didn’t have a different cost of goods, so what you do is you might divide that up evenly if it’s an even amount of units sold or divide by the percent of units you’ve sold,” Daly said. “An institution might want higher volume and lower price point. The margin will be lower, because you can’t sell it for as much. You may want to sell more volume and you’re willing to discount it. Or, you may sell at a smaller volume at higher prices. If you can break it down this way, you might see there are areas where you are not making as much money.”
Then you can ask, “Why is that?” he said.
Budgeting for Success
Daly explained the bottom-up budget.
“These are reversed from the five-line income statement,” Daly said.
Including income tax, the owner’s desired income goes at the top, followed by bank principal payments required. Added together, that is the total required net income.
Add to that, the overhead costs to get the required gross margin.
Divide the gross margin by 50% to figure out the required sales volume.
“A lot of farmers don’t pay themselves,” Radlin said.
That is why the bottom-up budget can make sure that farming is sustainable for a farm family.
Farmers who want to expand will need to evaluate if increasing production is worth it considering the increased expenses often associated with expansion.
“Whether you’re going to expand your operations or continue at the same level, you need a marketing and action plan,” Daly said. “Marketing isn’t just about more and more (customers), but selling more and adding value with the current customers you’ve got.”