By Betty Berning, Extension Educator
This is it- the last of the financial statement
articles. I promised I would write
three: one for each of the commonly used
financial statements on farms. I am sure
some of you are breathing a sigh of relief!
If you recall, I’ve written about balance
sheets- first article- and income statements- second article. A balance sheet tracks your assets (cash,
land, machinery) and liabilities (loans, mortgages, accounts payable). An income statement looks at your
profitability over time. For example,
your Schedule F from your tax return is an informal income statement because it
lists where you received and spent money.
This article will focus on cash
flow statement (CFS), the third financial statement. CFS is precisely that: a statement that explains the flow of cash in
your business. In other words, how did
money move in and out of your business?
Where did your income come from?
What kind of expenses did you have?
Imagine
that you looked at your 2015 and 2016 balance sheets. (See Figure 1) You notice there are changes. Your assets have increased by $107,000 and
your liabilities have increased by $54,900.
What happened? With a little
analysis, you can piece some of it together.
Long-term assets and long-term liabilities increased, so it would appear
that land was purchased and a portion was financed. You can see the basics, but don’t get the
in-depth view.
What about the current assets? There was a change of $4,000 from 2015 to
2016. What happened there? That’s not as obvious by just looking at the
balance sheet. That is where CFS comes
in. CFS helps tie the balance sheet and
income statement together.
Figure 1: 2015 and
2016 Balance Sheets
There
are three components to CFS: cash from
operations, cash from investing activities, and cash from financing activities. (Figure 2) Let’s define these terms a bit
further. Cash from operations is the
gross cash income and total cash expense.
These items can be found by looking at your tax statement, which lists
out your income and expenses. Cash from
investing activities consists of purchases and sales of equipment, machinery,
or land. Think about what you may have
purchased in the last year or may have sold.
Cash from financing activities are loan payments and withdrawals. It also
includes your nonfarm income and family living expenses. CFS is completed for a specified time period
(usually annually at the end of the year).
It will help you understand where money was spent.
Figure 2: Cash Flow
Statement
Beginning cash balance
|
$3,800
|
Cash from operations
|
+113,423
|
Cash from investing activities
|
-17,023
|
Cash from financing activities
|
-83,700
|
Ending cash balance
|
$16,500
|
How do
you know if you have a strong CFS?
You’ll have positive cash from operations. This means you have money for investing and
financing activities. Your money from
operations can be used to buy a new piece of machinery or cover family living
expenses. Another good sign is if your
ending cash balance is greater than your beginning cash balance. This shows that you were profitable during
the time period.
Your
lender will probably look at your term debt coverage ratio. This helps determine your capacity to repay
you debts. It is calculated using the
following equation:
Term Debt Coverage Ratio = Net Farm Income
Debt payments
A ratio of greater than 1 indicates your
operation is generating enough income to cover your debt payments. A ratio of less than 1 indicates that there
is not enough income to service debt.
Lenders like to see a term debt coverage ratio of 1.25 or greater. In others words, for every $1.25 of income
you generate, you can pay for a $1 of debt.
Don’t panic- many farms have less than desirable term debt coverage
ratios right now. If that’s you and you
haven’t talked to your lender, you need to do so. You need to develop a plan. That could be selling an asset, generating
additional income, or restructuring debt.
If
you are feeling confused after reading all of this, that’s okay. Re-read it and try to work through an
example. Review the cash flow statement
your banker or financial software have produced for you. What do you see happening in your business?
CFS
is the most difficult statement to understand, but it is very important. This is where you can identify if you have
enough money to pay your bills.
Additionally, it is one of the first places where financial distress
appears. Learn how to utilize this
statement and it will allow you to be a proactive financial manager.
Times
are tough right now. Keep engaging with
your lender and farm business manager instructor. Have conversations early and know your
options. Understand your business and
its finances. If you are interested in
learning more about financial statements, please consider using “Interpreting
your Financial Statements and Measures”, http://ifsam.cffm.umn.edu/. This is an on-line workshop series that will
help you understand your financial statements to more effectively manage your
farm. It will go into greater depth than
these articles and help you on your financial journey!
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