Cash Flow Projection for Operating Loan Determination

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1 Operating oan Determination Curriculum Guide I. Goals and Objectives A. Understand what a projected cash flow statement is. B. earn how to develop a projected cash flow statement. C. earn the benefits of using a projected cash flow statement. II. Description/Highlights A. A cash flow statement can be simply described as a recording of the dollars coming in and the dollars going out of a business. B. A record of cash inflow and outflow that has already occurred in a business is an actual or historical cash flow. The actual cash flow of a business provides important information for making a cash flow projection into the future. An estimate or forecast of cash inflow and outflow into some future period is a cash flow projection. The cash flow projection provides information on the cash generating ability and the cash requirements of a business and it indicates the timing of both. C. A cash flow can be set up for either the entire farm business (including family living expenses and non-farm income) or a segment of the business, such as a specific enterprise or profit center. D. A projected cash flow can be useful when analyzing a proposed change to the farm business. Two questions are of concern when analyzing proposed changes to the farm, short-run feasibility and long-run profitability. E. Short-run feasibility refers to the income-generating ability of a business in a short period of time, usually one year to three or five years in length. Short-run feasibility is usually studied through the use of a projected cash flow. F. ong-run profitability refers to a period of five to ten years or more and is usually studied through the use of projected income statements. In the income statement process, capital expenditures are prorated over the life of the assets by arbitrary depreciation methods Page 1

2 G. The Cash Flow Projection form in the inside fold of this leaflet has been developed to be used to study the short-run feasibility of a business change. It has been designed specifically to project the operating loan balance of a farm business for each monthly period. H. Information for preparing a cash flow projection may come form many sources including:! Records of actual cash flow or other farm records from past years.! Tax returns.! Publications listing investment requirements for crops and livestock enterprises (to determine projected periodic cash payments).! Publications listing feed requirements for livestock enterprises.! Price and yield estimates. I. The example cash flow projection form is designed to be used on a monthly basis; however it can be used for periods other than one month such as bimonthly, quarterly, semiannual or annual basis. J. It is usually easier to fill in the Annual Estimate first. Then, the annual estimate may be allocated to the various months or periods. K. In the example, line 16 shows the total cash inflow (not including loan receipts) and line 48 shows the total cash outflow (not including operating loan payments). Net cash flow, which may be positive or negative, is the difference between cash inflow and cash outflow and is shown on line 49 for the annual estimate and for each monthly period.. The projected operating loan balance for each month is calculated on line 50. In the example on the inside fold, the operating loan carried over from the previous December is $100,000. For each monthly period, the projected operating loan balance is determined by combining the previous balance with line 49 net cash flow for that period. A negative cash flow figure for a month increases the operating loan balance so it is added to the previous projected operating loan balance to determine the projected operating loan balance for that period. A positive net cash flow for a month has the effect of reducing the previous month s projected operating loan balance. M. For example, the March net cash flow of $115,800 (line 49) is subtracted from the February projected operating loan balance of $96,250 (line 50) leaving a March projected surplus of $19,950 (line 50). N. The projected operating loan balances (line 50) for each month can be used as a guide in projecting the approximate amount of loan funds needed and timing of the loan fund needs. O. A cash flow projection provides the farm operator with a basis for studying the financing of the business. It indicates how much needs to be borrowed and when it is needed. A cash flow projection also provides for control of the business. By 4-98 Page 2

3 comparing the projected cash flow to the actual cash flow that occurs, the variance of each item can be noted. If receipts are less than expected or expenses more than expected, the cash flow will alert the manager to a possible problem. P. A cash flow projection provides the basis for planning additional investments in the farm business. To be sound, an investment must be profitable in the long run and be able to generate enough cash to make the payments on principal and interest. Q. A useful measure of liquidity which can be derived from a projected cash flow budget or a statement of cash flows (actual cash flows) is the cash flow coverage ratio. Cash Flow Coverage Ratio = Total Cash Inflows (ine 16) divided by Total Cash Outflows (ine 48) R. In the example cash flow projection, the cash flow coverage ratio is: $406,000 / $401,500 = The cash flow coverage ratio assesses the business s ability to meet cash obligations. If the ratio is less than 1:1, the business is not liquid. The higher the ratio, the greater the liquidity. S. To fully benefit from a cash flow projection, comparisons to the cash flow statement (record of actual cash flows) must be made periodically. Doing this allows you to determine if, when, and where the actual cash flows vary significantly from the projections. This will allow you to detect potential problems in your farm/ranch business before they get out of control. III. Potential Speakers A. Agricultural enders B. Extension Economists C. Extension Ag. Agents IV. Review Questions A. To fully benefit from a cash flow projection, what step must be taken? Periodically compare the cash flow projection to your actual cash flow. B. What does the cash flow coverage ratio measure? It measures liquidity - the ability of the farm business to generate sufficient income to meet cash demands. V. Additional reference material A. Financial Statement Analysis, publication B-5047, Danny A. Klinefelter, Texas Agricultural Extension Service Page 3

4 Operating oan Determination A cash flow statement is a recording of the dollars coming in and the dollars going out of a business.! Types of Cash Flow Statements Actual cash flow Projected cash flow! Cash Flow Entities Whole farm Whole farm with family living Specific enterprises or profit centers 4-98 Page 1

5 Operating oan Determination! Benefits of a Projected Cash Flow Analyze short-run feasibility of a change in farm business Provides control of the business Compare projected vs. actual Basis for planning additional investments in the farm Can measure liquidity - cash flow coverage ratio 4-98 Page 2

6 Operating oan Determination! Information for Preparing Projected Cash Flow Tax returns Publications on: investment requirements for crops and livestock feed requirements for livestock enterprises Price and yield estimates! Example Projected Cash Flow Total cash inflow Total cash outflow Net cash flow (positive or negative) Projected operating loan balance 4-98 Page 3

7 Operating oan Determination! Cash Flow Coverage Ratio Measure of liquidity (ability to generate cash income to meet cash demands) Total Cash Inflows (n 16) Total Cash Outflows (n 48) $406,000 = 1.01 $401,500 Assesses the business s ability to meet cash obligations Ratio of less than 1:1 means the farm business is not liquid. The higher the ratio, the greater the liquidity 4-98 Page 4