#154 Your Cash Flow is Lying to You

SW Financial Literacy

Your Cash Flow is Lying to You

I hear this all the time from producers, “I can’t afford to buy ground. It doesn’t cash flow.”

In the land cohort this week we covered that while cash flow is important, it’s not the correct place to start when determining if you can buy ground. So many producers get this wrong. They are distracted by cash flow when exploring buying ground. Distracted by cash flow? How? Let me explain.

Let’s take a look at Johnny. Johnny is looking to buy ground and he’s not eligible for FSA joint financing. This would be his first land purchase so he’s going to need to come up with a big down payment to be able to acquire traditional financing. Johnny talks with the lender to discover how much financing he can get from the local bank.

That financing number tells Johnny how big his loan payments will be every single year for decades. Johnny sees that number and pencil it into his cash flow. Either it works or doesn’t. If it doesn’t, Johnny sees he can make it work at $5/bu corn and either lowers his max bid or bites the bullet and says a prayer. 

This is how most producers approach land sales. It is one of the worse things you can do, potentially putting your operation in a stalemate for the next decade or longer.

Here is what you should do:

Pull up your previous three years of balance sheets. Have you had net worth gains or losses each of the past three years? If you’ve had losses in two out of the past three years, your operation is losing too much money. You need to focus on becoming more efficient today instead of making a land purchase. Adding land doesn't spread out expenses, it makes inefficient operators worse.

If you pass with net worth earnings, you may proceed forward.

Now for your cash. Is working capital at least $300 per acre before the purchase? What has been the direction of working capital each of the past three years? If you have been bleeding working capital and are below $300/a you shouldn’t look to make the purchase.

Next factor in the down payment required and new loan onto balance sheet by running a purchase scenario (more on purchase scenarios below). Is your working capital still above $300 per acre? If not, you need to make a smaller down payment and finance more. 

With the new debt on your balance sheet, did your equity/asset ratio fall below 45% for an established operation or 30% for a producer less than 10 years? If it did, this is too much debt for your operation to be able to take on right now. You need to pay down debt, build equity, or make a smaller purchase instead.

All these need to be done on the balance sheet before looking at cash flow for a purchase.

Running the cash flow with a new purchase is just a second check, but is often overstated by the producer and inaccurate. I can tell if you can make the purchase work 90% of the time by looking just at the balance sheet.

The balance sheet tells if you can afford the purchase from a cash position, total debt load, and operational earnings. A cash flow does NONE OF THIS. Your cash flow is lying to you.

This is exactly why I created farmbalancesheet.com. You can enter your balance sheet, get expert feedback on your position, and run simple purchase scenarios all in the same place. I’ve made it easy for you.

Save time and get the coaching you need for your next purchase right from your office computer, all for less than a tank of gas.

www.farmbalancesheet.com

Have a great week!

Grant