In my last article I presented some ideas about the factors that contribute to being a good agricultural business owner.
As we come to the end of another financial year, this article considers some aspects about the financial health of a business.
My comments are based on an article originally attributed to Lincoln Indicators, a finance advisory firm,which points to three main indicators of good business health, being:
- The generation of consistent profits
- Strong operating cash flows
- A sound debt position.
Generate consistent profits
The annual profit figures of complex businesses can be received with scepticism.
This is due to the differing interpretations of accounting guidelines, and instances where a company has collapsed after producing seemingly positive accounts or receiving a sound audit report.
Strategies to minimise tax can also distort the actual performance attained by a business.
Profit & Loss Account
Despite these shortcomings, the annual Profit & Loss Account is still the best objective indication of business performance, and tax-driven anomalies tend to smooth out when profits are viewed over a number of years.
Profits are the cheapest and safest form of business funding and, given owners don’t generally have much additional capital to add to a business, are the only source of funding aside from borrowing.
An appropriate profit should be generated in most years, and good profits should be generated over time. To determine the latter, look in your Balance Sheet for the business’s retained profits figure—or partnership balance carried forward. This figure should be positive, and the higher the better.
Earning good profits enables a wider choice of decisions to be made, and provides the best opportunity for the business to experience good cash flows.
Strong operating cash flows
At any time, but especially during difficult periods, business liquidity through cash flow is fundamental to a healthy business.
For an agricultural business, annual cash flow should be sufficient to cover family living expenses, repay current borrowing requirements, enable new business investment, and contribute to off-farm investment (where that off-farm investment provides a greater return than farming).
Statement of Cash Flows
The accounts of large companies generally include a Statement of Cash Flows that indicates how the business generated and spent its cash flow.
Farm accounts typically do not have such a statement, so it can be difficult to understand just where the money goes each year.
At a very basic level, operational cash flow equates to net profit plus depreciation. The resulting figure can then be compared to your version of the cash flow requirements noted above, for living expenses, and so on—you will generally know those figures.
Profit not the same as cash flow
However, profit is not the same thing as cash flow.
Cash flow is also influenced by movements in debtors, creditors, stock and capital payments.
For example, if the family decides to pay itself more this year, or to buy a new car instead of keeping the current one, then those decisions will have an effect on cash flow outside the business’s profit performance.
Again, it is critical that cash flow covers your needs in most years. If it does not, then borrowings tend to rise, or there is tension with the bank about the overdraft.
A trend of under performing cash flow needs to be addressed early before the business gets into serious difficulty.
If there is any doubt about how cash flow moves through your business each year, ask your accountant to prepare a Statement of Cash flows when they are preparing your annual accounts. It does not take long for an accountant to perform that task.
For the sake of a few more dollars, that statement is one of the most important documents in your business, and is a good way of understanding how cash funds move.
Manageable debt levels
A discussion of cash flow leads to comments about debt. Continues next issue
See this article in Tree Fruit, July 2013
