Volatility may be an over-used word but it’s the main reason for dealing with another sometimes unpopular concept – budgeting. .
There are lots of good reasons to budget but the key one is that it gives more control over business decisions.
A budget shows expenditure and income over a period, usually a year. The big problem with a budget is that the day after it is drawn up, it will probably be out of date.
However, this is no reason for reluctance to complete a good budget, say advisers and once a budget is in place, this gives the basis from which to consider system changes or improvements.
- Sounds basic but double-check all spreadsheet formulae and entry information – for example, is there the correct number of milk cheques or other payments/receipts
- If the end result is a surprise (good or bad) – check information and formulae again
- Know costs of production down to a net profit level, not just gross margin
- Reality check the budget against the totals in the previous year’s accounts – of course, every year is different but this can help initially to identify mistakes, over or underestimates and omissions
- Don’t forget to allow for private drawings, tax bills, life assurance and other insurance premiums
- If on rented land, consider likely rent changes
- While targets can be useful, they have to be based on realistic assumptions about the ability to achieve them
- Use benchmarking data (for example, from QMS, EBLEX, HGCA, Dairyco) to see what similar businesses in similar areas are capable of both physically and financially to give insight into your own performance and potential. Sometimes miscellaneous expenditure such as silage wrap and minerals can account for big variations in farm performance
- Don’t put the budget on a shelf and forget about it. Continually review and monitor actual against budget, and then using this as a tool to adapt and help forward planning
Budget reality checks
- Past performance (three to five-year average), not expectations of what might be, should guide output assumptions
- Be honest – don’t put expenditure lower than in previous years unless there is a sound basis for doing so
- Milk sales – milk produced is not the same as milk sold; there will always be a waste milk element which should be accounted for
- Stock performance – account for the tail-enders as well as the good stock, also lambs likely to be finished and sold, not simply ewes put to tup and a lambing percentage forecast
- Grain – remember to account for on-farm use; stock feed and seed are obvious but game feed can add up too
- Straw value – many arable operators don’t want straw to leave the farm but its sale value should be considered
“The distinction must be made between a budget and a target,” says Charles Holt of the Farm Consultancy Group. “A budget is what you think is actually going to happen. If, having done a budget, the end result is a surprise, good or bad, don’t just accept it, question it.”
Advice from the Farm Consultancy Group
Making budget adjustments
If the budget is radically different from the outcome of previous years, this should also be questioned to justify any changes.
“Look back at previous budgets – it’s very easy to be optimistic and if you are consistently not up to budget then you should adjust your approach” Charles Holt.
Banks are increasingly asking for more detailed budgets from their business customers but drawing up a budget just for the bank is pointless, say advisers.
“It’s crucial that farmers engage with the process,” says Mr Holt. A properly constructed budget which is monitored through the year puts a business in a position to assess progress, make adjustments if necessary through the year and plan expenditure and tax more carefully and efficiently.
For example, monitoring can help with making a decision to bring forward or postpone expenditure or to claim a reduced payment on account for tax.
Sensitivity is a crucial element of forward planning – once the budget is done, the impact of changes can be studied. For example, what happens if the milk price changes either way by 1p/litre, or if grain or fuel prices move.
“What effect will that have on the overdraft and cashflow; sensitivity allows you to test the budget and weigh up your options.”
While one-year budgets are most common, if the outcome of a one-year exercise doesn’t look right, then it is sensible to look further ahead and this is essential for anyone making changes to their system, taking a look forward for say five years, says Mr Holt.
As the year progresses yields become known, sales have been made and input prices may have varied from the original budget figures, then you can adjust the budget to give a forecast for the end of the year.
Volatility, a poor harvest in 2012 followed by a late, cold spring for most and a disastrous snowy spring for some, means that budgeting has probably never been more important, says Andrew Macdonald of consultant Laurence Gould.
Key to a good budget is being realistic and honest with yourself, he says.
“If your land is not capable of 12t/ha of wheat every year, then don’t budget for it – you will only be disappointed. You know your farm’s past performance and future potential as well as anyone else, so are ideally placed to prepare a realistic budget.
“Wherever possible, try to use real physical and financial data from your own farm business to help inform and prepare the future budget. Too often budgets are based on theoretical possibilities rather than being grounded in the facts of how the farm has performed historically.”
Mr Macdonald favours starting with individual enterprise budgets and then amalgamating them into the whole farm budget.
“This adds the ability to compare the relative performance and profitability of different enterprises on the farm. Another very useful “reality check” is to compare your own power and machinery costs with carrying out the same operations using a contractor – is using your own machinery significantly cheaper? If not, does the extra convenience/timeliness/accessibility outweigh the additional costs?”
Budgeting should begin about six months before the period for which the budget is being drawn up, says Mr Macdonald, who also urges close cash monitoring and keeping the bank informed.
“Banks are generally more risk averse now than a few years ago, and even for farm businesses making good profits, swings in cashflow are now much more significant.
“All farm businesses are likely to have bigger working capital requirements now than ever before. Most banks are still happy to lend towards this, as long as they can see that it is affordable, how much the return will be, and when it will be too.
See also: How to prepare for a VAT inspection