www.ebbemunk.dk Bookkeeping and Farm Economics

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Chapter 6: Production and Financial Planning

What will happen in future? You do not know which changes in production will be the most profitable, if you do not make calculations. If is important to make realistically economic calculations before you decide investments. It can be a difficult task to make the calculation, but still it will give a good idea of the economic conditions.

Profitability: If you need to borrow money, the bank will ask to see a financial and production plan. The bank wants to see, whether the investment will be profitable. The increase in income must be larger than the increase in costs.

Liquidity: Will you have cash enough to pay the credit back? You must be able to provide money to pay interest and instalment of the credit meant for investment.

When your conditions change, there may be need for a production and financial plan. The limiting conditions may be:

• Changes in production efficiency
• Enlarging or changing the production
• Lack of cash
• Lower prices
• Changes in market situation

To make it possible for you to judge, both when you want to know

• Whether you will make profit on the existing production under changed conditions or
• You will make profit on a changed production
• You will not run out of cash in the coming period

When showing alternatives in a plan, it is most convenient to show only one change at a time, for example not in two columns:

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It will be better with three columns:

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It is most common to make a plan for one year. On the other hand, it cannot tell you how income and costs will be distributed throughout the year. Maybe there is a need for dividing the year in quarters or months.

The production and financial plan can show

• Profitability: The expected economical result for the coming period
• Liquidity: The cash flow in the period.

You can show the expected result based on the expected Gross Margins of the single productions: Gross Margins - Fixed Costs = Surplus

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In this example, the farmer and his consultant expect a considerable improvement of the Gross Margin per sow. Nearly all of the improvement in the Total Gross Margin is originating from this improvement.

Using the plan, you can calculate how long the farmer's money will last. When you use your income to invest in new machines, buildings, larger livestock, etc., you may run out of money even if you are improving your surplus.

The expected cash incomes in year 2 will be 155000 kroner, which is more than the expected surplus of 127000 kroner. That is because parts of the fixed costs shown are not in cash.

Depreciation is not a cash cost like costs for fertilizer, seed, etc. Costs for buying machines and buildings are not deducted directly in the accounts in the year of the purchase. They are not used up at end of the year of purchase, and the cosa of using these goods are instead distributed over the expected years of use. Every year the machines and buildings are worn, and they loose value.

The expected cash incomes is the amount, that is at disposal to pay interest and instalment, land rent, investments, and private costs like consumption and income taxes.

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As you see, neither in year 1 nor year 2 the new credit was sufficient for covering all of the farmer's need for cash. The One-year Liquidity Plan shows, that all of the planned investment in the sow stable must be financed by credits. 45000 kroner are covered by a new credit, and the farmer will hopefully find rest of the money on his bank account.

Short-term Liquidity Plan: Newly established farmers and farmers, that make larger changes in their production, may use a Liquidity Plan for shorter periods than one year. As a basis you use cash results from corresponding periods one year earlier.

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