Money management basics

Money management basics A guide to DairyNZ s budgeting tools dairynz.co.nz 0800 4 DairyNZ (0800 4 324 7969)

Contents Why is business profitability so important? 5 Why budget? 5 Budgeting basics 6 Step by step guide to using the DairyNZ Quick Cash Budget 7 Step by step guide to using the DairyNZ Annual Cash Budget 14 Step by step guide to using the DairyNZ Monthly Cashflow Budget 23 Step by step guide to using the DairyNZ Personal Cash Budget 38 Other budgeting tools 42 Budgets - what next? 43 Glossary 47 Notes / calculations 51 3 Money Management Basics

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Why is business profitability so important? Profit provides choices. Profitability doesn t usually happen by accident. Choices enable farmers to expand the business, reduce debt or pay themselves higher drawings. Why budget? Budgeting allows you to: Take financial control of your business Assess the viability of new proposals, borrowing or ventures Plan cash income and expenditure. The starting point for improving business performance is a plan. The plan should reflect the input of all key stakeholders (husband and wife, equity partners, company directors). The challenge of running a business is being able to make decisions, because being able to make decisions ultimately shapes where you will end up. Without a budget it is difficult for the manager of a business to be proactive and as a consequence they tend to react to situations, which is often too late. Having someone from outside the business included in this process, questioning your assumptions, can be very useful. Remember financial control of your business rests squarely on your shoulders. 5 Money Management Basics

Budgeting basics An annual cash budget indicates if the business is sustainable and viable. It will tell you if you can expect a cash surplus or deficit (loss) at the end of the season. The process of creating a cash budget is simple, you will need: A budgeting tool, for example: - Spreadsheet - Budgeting software - Pen and paper. Good accurate records for forecasting the coming season - Production - Stock reconciliation - Financial records. Uninterrupted time set aside Input from key partners. If you don t have last year s accounts, expenditure estimates can be obtained from various sources, such as: The DairyNZ Economic Survey (0800 4 DairyNZ or 0800 4 324 7969 or dairynz.co.nz) Your bank manager Your accountant or business consultant The Lincoln University Financial Budget Manual Your local DairyNZ consulting officer. Historical records may reveal trends in the business that need to be accounted for. Money Management Basics 6

Step by step guide to using the DairyNZ Quick Cash Budget The attraction of completing a Quick Cash Budget is that a big picture overview of the business can be gained very quickly. Many people know their Farm Working Expenses and can estimate debt servicing and drawings relatively easily. A quick budget simplifies both milksolids income and farm working expenses, so that a budget can be quickly prepared so as to gain an overview of the business. For example, if we receive $5.50/kgMS in milk revenue and another $0.26 in livestock sales, we have a total income of $5.76. Where is this going? If we are spending $3.25 on FWE, $1.39 on debt servicing and $0.61 on drawings, that leaves us $0.51 spare without any other expenses. It provides us with a quick look at the situation. Getting started Take advantage of the rural professionals who support your business rural bankers, veterinarians, farm consultants, supply store staff and company representatives (i.e. fertiliser reps). They will be able to provide you with a range of valuable information on market trends, input costs, and general advice on how to fine tune your business to be productive and profitable. Name, date and farm information Start with the physical details for the season you plan to forecast and what period this budget is for, e.g. 1 June 2010 to 31 May 2011 Establish a production target for the coming season 7 Money Management Basics

Working out income for your farm business Milksolids production and payout Use your production target for the season and decide on a payout figure Contact your dairy company representative Speak to your banker. What signals or information are out there in the market? Look for commentary from your dairy company, banks, MAF, DairyNZ and others to help estimate the payout. Forecast your milk income at a conservative level in your budget and then review as necessary. Net Livestock sales Look at stock reconciliations from previous seasons Add together likely sales of calves, bobbies, culls and so on Subtract from this any purchases you may make during the season. Other income Using the template as a guide, work out other dairy income from rent, rebates, stock leases etc Many farm businesses have other sources of income during the season. Estimate your likely income for the year from sources such as income equalisation and off-farm wages or non-dairy operations. Calculating total income Add together dairy cash income and total in the Net Dairy Cash Income cell Now add the remaining non-dairy items and you have Total Income. Production target Use the most likely predicted payout Add these to get Net Dairy Cash Income Money Management Basics 8

Obtain assistance from your bank manager, consultant or accountant, but take charge and get very good at budgeting. Calculating income and expenses for $/kgms, $/cow, $/ha For the income section you will have filled in the $ Total column If you have $ Total figures then dividing any of these amounts by either total milksolids production for the season, peak cows or hectares will give you income per kgms, per cow and per hectare. Same figure Total Milksolids Income ($673,750) cows (350) = $1,925/cow Total Milksolids Income ($673,750) ha (125) = $5,390/ha 9 Money Management Basics

Working out expenses for your farm business Farm Working Expenses (FWE) Use your last two to three years sets of financial statements When estimating FWE remember to allow for increased costs, for example, changes in costs due to on-farm inflation. What to do if you have a per kgms, per cow or per hectare figure One way to complete the remaining cells is to take the $ per cow/kgms/ha number and multiply it by cows/milksolids/hectares to give a total farm figure. E.g. If I estimate FWE to be $3.25/kgMS then $3.25 x 122,500 milksolids = $398,000 total. FWE $/kgms ($3.25) x kgms (122,500) = FWE Total $398,000 Budgets prepared without using historical accounts generally overestimate cash surpluses. Money Management Basics 10

Total Expenses There are a number of other cash expenses during the season, refer to previous financial accounts for help If you don t know your total interest bill for the season check with the bank If you plan to pay off principal during the season or increase borrowings calculate this in the Net Debt row Tax should be calculated last (after all income and expenses have been forecast) by either using the Tax estimator at the foot of the template or by contacting your accountant Now that all columns have been completed calculate your Total Expenses figure Do this for each column ($ Total, per kgms, per cow, per hectare). DairyBase benchmarking reports for your region are a good check to determine average FWE and so on. Remember, if trimming back costs is your goal you may prefer to be benchmarked against the Top 50% or Top 20% of farms in your region. Talk to your accountant or DairyNZ consulting officer. Check with bank Estimating tax: Total income $729,750 - FWE $398,000 - other expenses $5,000 - rent $10,000 - interest $170,000 - depreciation $50,000 Taxable profit = $96,750 $96,750 x 30% = $29,025 The DairyNZ Economic Survey is published annually and contains tables of average farm financial data for the past decade. There is also a forecast section which may help indicate trends in the current season. Order a copy online by visiting dairynz.co.nz 11 Money Management Basics

Calculating a cash surplus or deficit for your farm business Total Income less Total Expenses gives either a cash surplus or cash deficit for the season. Total Income ($729,750) - Total Expenses ($697,025) = Cash Surplus/Deficit ($32,725 surplus) Money Management Basics 12

What next? You ve completed your Quick Cash Budget - fantastic. Take some time now to digest what you have found and consider the implications. If you have a surplus, great. You need to ask yourself how you will use this surplus. If your budget shows a loss accept this, don t hide it. Everyone involved in your business needs to know where you stand. Refer to Budgets what next? for more details. The next step in budgeting is to complete an Annual Cash Budget for your business. An annual cash budget is a traditional budget detailing cash income and expenses. It indicates if the business is sustainable and will tell you if you can expect any cash surplus or a deficit (loss) at the end of the season. If you d like to gain a better picture of cash requirements (including working capital) during the season, then move on to completing a Monthly Cashflow Budget. The Monthly Cashflow Budget allows you to drill-down into expenses on a month-by-month basis. When doing your budget prepare three scenarios best case, most likely situation, and a war budget. Only put the absolute essentials in your war budget this budget may not be sustainable for the long term, but it will help during times of tight cashflow. 13 Money Management Basics

Step by step guide to using the DairyNZ Annual Cash Budget Getting started Take advantage of the rural professionals who support your business rural bankers, veterinarians, farm consultants, supply store staff and company representatives (i.e. fertiliser reps). They will be able to provide you with a range of valuable information on market trends, input costs, and general advice on how to fine tune your business to be productive and profitable. Name, date and farm information Start with the physical details for the season you plan to forecast and what period this budget is for, e.g. 1 June 2010 to 31 May 2011. Establish a production target for the coming season Under estimate and over deliver. When budgeting, it is best to underestimate production and payout expectations, and over estimate expenses. Money Management Basics 14

Completing the payout income section Working out income for your farm business Milksolids production and payout - The advance is paid on predicted production for the season ahead - Final payments are made on last year s production - Dividend payments may be based on last season s shareholding or occur during the forecast budget season, use the Advance Payment Rates Schedule or check with your dairy company representative to confirm this income. Forecasting payout methods - Use the Advance Payment Rates Schedule if available - Log in to www.fencepost.com and use the Payment Predictor in the Tools and Resources section - Contact your dairy company representative - Speak to your banker. What signals or information is out there on the market? Look for commentary from your dairy company, banks, MAF, DairyNZ and others to help estimate the payout. Forecast your milk income at a conservative level in your budget and then review as necessary. Production target coming season Last season s production Use advance payment rates schedule 15 Money Management Basics

Completing the income section Net Livestock sales Look at stock reconciliations from previous seasons Add together likely sales of calves, bobbies, culls and so on Subtract from this any livestock purchases you may make during the season. Other income Include other dairy income from rent, rebates, stock leases etc Many farm businesses have other sources of income during the season. Estimate your likely income for the year from sources such as income equalisation and off-farm wages or non-dairy operations. Calculating total income Add together dairy cash income and total in the Net Dairy Cash Income cell Now add the remaining non-dairy items and you have Total Income. Dairy livestock sales less purchases Obtain assistance from your bank manager, consultant or accountant, but take charge and get very good at budgeting. Money Management Basics 16

Working out income and expenses on a per kgms, per cow and per hectare basis For the income section you will have filled in the $ Total column - If you have $ Total figures then dividing any of these amounts by either total milksolids production, peak cows or hectares will give you income per kgms, per cow and per hectare. Net livestock sales ( $32,000 ) kgms (122,500) = $0.26 Milksolids advance ( $551,250 ) cows (350) = $1,575 Milksolids advance ( $551,250 ) hectares (125) = $4,410 Budgets prepared without using historical accounts generally over estimate cash surpluses. Working out expenses for your farm business Farm Working Expenses (FWE) Use your last two to three years sets of financial statements to compare expenditure When estimating FWE remember to allow for increased costs, for example, changes in costs due to onfarm inflation Work through the FWE categories systematically, examine each item of expenditure. It will take some time but it is worth the effort Develop your budget on common units of production, e.g. per cow, per kilogram of milksolids or per hectare. Then multiply costs by the units produced Add each column of FWE so that you can see Total FWE as a total, and expressed per kgms, per cow and per hectare. A common mistake is that people assume they will not have any unexpected capital expenditure, for example, a quad bike, or tractor. Allow for unexpected items that have to be replaced or repaired if they break down. 17 Money Management Basics

Total rates bill $9,000 Total rates ($9,000) kgms (122,500) = $0.07/kgMS Total rates ($9,000) cows (350) = $26/cow Total rates ($9,000) ha (125) = $72/ha Nitrogen $80/ha $/ha (800) x ha (125) = $10,000 total nitrogen Nitrogen total ($10,000) kgms (122,500) = $0.08/kgMS Nitrogen total ($10,000) cows (350) = $29/cow Calculating $/kgms, $/cow, $/ha for expenses Some expenses are best known on a totals basis (eg rates), while others are commonly expressed per kg milksolids (eg wages), or per cow (eg animal health), or per hectare (eg fertiliser). Start with the figures you know best and calculate the information from that. What to do if you have a per kilogram milksolids, per cow or per hectare figure One way to complete the remaining cells is to take the $ per cow (or per kgms or per ha) number and multiply it by cows (or milksolids or hectares) to give a total farm figure - e.g. If I estimate Animal Health costs to be around $65 per cow and I have 350 cows, the total farm spend on animal health is $65 x 350 cows = $22,750. $65/cow x 350 cows = $22,750 Total Animal Health ( $22,750 ) kgms (122,500) = $0.19/kgMS If you are unsure where to put particular expenses refer to the DairyBase definition or ask your accountant. Remember to include transport or cartage for feed purchased and grazing. Money Management Basics 18

Calculating total expenses Total expenses There are a number of other cash expenses during the season, refer to previous financial accounts for help If you don t know your total interest bill for the season check with the bank If you plan to pay off principal during the season or increase borrowings calculate this in the Net Debt row Tax should be calculated last (after all income and expenses have been forecast) by either using the Tax Estimator at the foot of the template or by contacting your accountant Now that all columns have been completed add FWE to all the other expenses to calculate your Total Expenses figure Do this for each column ($ Total, per kgms, per cow, per hectare). DairyBase benchmarking reports for your region are a good check to determine average FWE. Remember, if trimming back costs is your goal you may prefer to be benchmarked against the top 50% or top 20% of farms in your region. Talk to your accountant or DairyNZ consulting officer for more help. Estimating tax: Total income $739,500 - FWE $398,000 - other expenses $5,000 - rent $10,000 - interest $170,000 - depreciation $50,000 Taxable profit = $106,500 $106,500 x 30% = $31,950 Estimate only - does not allow for other adjustments such as livestock valuation. Be realistic - look at past accounts 19 Money Management Basics

Calculating a cash surplus or deficit for your farm business Total Income less Total Expenses gives either a cash surplus or cash deficit for the season The DairyNZ Economic Survey is published annually and contains tables of average farm financial data for the past decade. There is also a forecast section which may help indicate trends in the current season. Order by visiting the DairyNZ website dairynz.co.nz Money Management Basics 20

What next? You ve completed your Annual Cash Budget - fantastic. Take some time now to digest what you have found and consider the implications. If you have a surplus, great. You need to ask yourself how you will use this surplus. If your budget shows a loss accept this, don t hide it. Everyone involved in your business needs to know where you stand. Refer to Budgets what next? for more details. If you d like to gain a better picture of cash requirements (including working capital) during the season, then move on to completing a Monthly Cashflow Budget. The Monthly Cashflow Budget allows you to drill-down into expenses on a month-by-month basis. When doing your budget prepare three scenarios best case, most likely situation, and a war budget. Only put the absolute essentials in your war budget this budget may not be sustainable for the long term, but it will help during times of tight cashflow. 21 Money Management Basics

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Step by step guide to using the DairyNZ Monthly Cashflow Budget Getting started Take advantage of the rural professionals who support your business rural bankers, veterinarians, farm consultants, supply store staff and company representatives (i.e. fertiliser reps). They will be able to provide you with a range of valuable information on market trends, input costs, and general advice on how to fine tune your business to be productive and profitable. If you have completed an Annual Cash Budget have this ready to transfer numbers from. You may need to refer to historical accounts or bank statements. Name, date and farm information Start with the physical details for the season you plan to forecast and what period this budget is for, e.g. 1 June 2010 to 31 May 2011. Establish a production target for the coming season Start with the physical details for the season you plan to forecast and what period this budget is for, e.g. 1 June 2010 to 31 May 2011. Working out income for your farm business Annual Total $ Fill in the first column, Annual Total $, with figures from your Annual Cash Budget Now you have your yearly income and expenditure ready to spread across the months in your budget. Annual totals from your Annual Cash Budget * Note: Example budget is based on a $5.50 payout ($5.10 milk price and $0.40 dividend). 23 Money Management Basics

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Milksolids production & payout online calculations Log in to www.fencepost.com and use the Tools & Resources to estimate monthly milk cheques Firstly you need to calculate monthly production - Use the Target Milksolids tool - Enter your total production target for the season - Click on Estimate Monthly - Make a note, save or open another window to use the monthly milksolids estimate to forecast milk income. Now open the Payment Predictor tool to forecast income - Tick the I want to run scenarios box - Fill in monthly milksolids production - Select Update Scenario to estimate payments - Transfer these figures into your Monthly Cashflow Budget. Any time that the advance is changed it is necessary to update your budget. Milksolids production & payout manual calculations Forecast how many milksolids you expect to produce each month - Estimate this from previous years production or, - Calculate from predicted production per cow and the number of cows expected to be in milk each month or, - Ask your Dairy Company representative or Bank Manager what percentage of production to expect for this area in each month. For the advance income multiply each months production by the advance rate Remember the income is paid the month after production occurred For the final payments multiply last seasons production by last seasons retrospective payments Calculate the dividend component - refer to the Advance Payment Rate schedule (note this is quite complicated as some is from last seasons shareholding and some is from this years shareholding). Check dairy company schedule August milk cheque from July s production 25 Money Management Basics

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Dairy cash income distribution Net livestock sales When do you plan to sell calves, culls or other stock? Enter any income in the months you receive it. Remember you may receive the payment for stock sale in the month after you actually sell them. Eg sell culls in January and April and receive the income in February and May If purchasing and selling stock in the same month then subtract purchases from sales If you make plan to purchase stock at a time when there will be no livestock sales, put in the forecast purchase figure as a negative number (e.g. purchasing five bulls in September, -$3,000). Other dairy cash income Is this income spread evenly over the year, e.g. farm cottage rental? Net dairy cash income Add up income from dairy farm operations for the season for each month Check that monthly income equals the annual total in the first column. Add monthly income and check against Annual Total $ Distributing total income across the season and checking totals Other Income Income equalisation and funds introduced - Check with your accountant or use historical records - It may be difficult to predict when other funds are introduced, talk to involved parties to help decide which month/s to allocate this income to. Check income for each month Check that you have distributed income accurately across the year by adding together each month. Check June to May equals Annual Total $ Calculate GST when you have finished working out income and expenses for each month. 27 Money Management Basics

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Distributing Farm Working Expenses across the season Farm Working Expenses Using the Annual Total $ figures for each farm working expense decide when during the season you would expect to pay the expenses Use historical financial records, receipts, bills or your diary or calendar from last season Some expenses are spread evenly across the year, e.g. wages may be paid monthly so divide the annual total by 12 (don t forget any casual labour) Some expenses might occur in one lump sum, eg insurance Add together each column, month by month, of Farm Working Expenses and check against the Annual Total $ figure. Working out when your farm working expenses will be paid will take a bit of time. Be as accurate as possible, use previous financial records. When you have completed it you will have a valuable overview of your farm financial situation that you can use each season. Insurance paid monthly. $5,000 12 = $417 Majority of animal health spend is in Spring Add expenses for each month and check against Annual Total $ 29 Money Management Basics

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Calculating other expenses Total Expenses Using the Annual Total $ figures for each other expense decide when during the season you would expect to pay the expense - This section may contain expenses you will simply divide by 12 and spread out across the year, e.g. rent or leased items, drawings, interest - Are you increasing borrowings? When will you need to do this? - If you plan to pay principal decide when this could be done, you may have to wait till your term debt rolls over onto a new rate (check with the bank). Don t add the Total Expenses together until you have calculated GST payments or refunds for each month. Same drawings each month. $75,000 12 = $6,250 Machinery purchase planned in June 31 Money Management Basics

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Calculating GST (15%) Refer to the IRD375 GST Guidebook for help in calculating GST Add together GST-related income and multiply by 3/23 to estimate GST on income Add together GST-related expenses and multiply by 3/23 to estimate GST on expenses. Check with your accountant or use the IRD Guide to help decide what expenses and income include GST. Items such as wages paid or off-farm income from wages should be excluded. Subtract GST expenses from GST income and fill in the GST payment/(refund) row If GST on income is greater than GST on expenses you will have a GST payment If GST on expenses is greater than GST on income you will have a GST refund. GST on income. June $18,333 x 3/23 = $2,391. July $20,333 x 3/23 = $2,658 GST on expenses. Add GST related expenses then multiply by 2/23 (exclude wages, ACC, interest, tax, drawings and net debt) Add June and July s GST on income and subtract June and July s GST on expenses. ($2,391 + $2,652) - ($4,601 +$3,582) = $3,249 GST refund in August. Annual GST on income - GST on expenses. $93,848 - $51,691 = $42,156 GST from one season may be paid/received in the previous or next season. Inland Revenue offers a free service with Liaison Officers who will come to you to discuss GST, wages, taxes, record keeping and so on. Or you can visit your nearest IRD office. 33 Money Management Basics

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Calculating the total expenses for the season Add the other expenses to your farm working expenses to get Total Expenses Remember to subtract GST if a refund is being claimed for the month The Total Expenses figure will have changed from your Annual Cash Budget or Quick Cash Budget figure as GST has now been added/subtracted. Make sure all expenses from June to May equal the Annual Total $ figure in the first column, e.g. add up wages from June to May and see that they equal the starting Annual Total $ figure. Add each month to get total expenses. If GST refunded remember to subtract GST from Total Expenses Add GST payment/refund to the original total expenses. $699,950 +$42,156 = $742,106 Calculating a monthly cash surplus or deficit for your farm business Now that all columns have been completed you can see which months will have a cash surplus or a cash deficit Calculate each months surplus or deficit by deducting Total Expenses from Total Income, fill in this figure for each month. Total income - total expenses = cash surplus/deficit. $18,333 - $72,130 = $53,797 Calculate the annual surplus or deficit. 35 Money Management Basics

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Calculating the bank balance Write your opening bank balance underneath the Cash Surplus/Deficit row The opening balance plus the cash surplus/deficit for June equals the closing balance for June - For example, $10,000 opening bank balance + -$53,797 deficit = -$43,797 closing balance The closing balance for one month becomes the opening balance for the next month and so on. The closing balance row of the budget will shed light on working capital and overdraft requirements. Opening balance + cash surplus/deficit = closing balance. -$21,801 (August closing) +$59,143 = $37,342 surplus Opening balance + cash surplus/deficit = closing balance. $10,000 + -$53,797 = -$43,797 deficit Opening bank balance A monthly cashflow forecast for the season is a valuable tool for management of the farm business and for use with external parties, particularly your banker. By reviewing forecast cashflows early with your banker facilities can be put in place to deal with any cashflow constraints. Conversely, if the farm business is generating good cash surpluses then a discussion with your banker or farm consultant around the management of a surplus may be valuable. 37 Money Management Basics

Step by step guide to using the DairyNZ Personal Cash Budget A Personal Cash Budget is useful for anyone who wants to know where their money is going. Completing a personal budget gives greater control over personal expenditure and lets you determine where savings could be made for larger items, such as overseas holidays, or to build up a sum of money for future investments or retirement. Start by getting organised. Find bank statements, bills and receipts. These will help you see where your money is being spent (rent, mortgage, hire purchase, telephone, power, insurance, groceries and so on). Working out your personal income Start with salary and/or wages for you and your partner - This may be drawings from the farm Other sources of income - Do you receive interest from a savings account? Working for Families assistance? It is often easier to think of income and expenses in per week or per fortnight or per month amounts and then multiply out for the number of weeks (52), fortnights (26) or months (12). Call 0800 774 004 to make sure you re getting your Working for Families entitlements you may qualify for Working for Families Tax Credits, the Accommodation Supplement or Childcare Assistance. $1,450/fortnight x 26 fortnights = $37,700 salary annual income Add these to get Total Income ($63,000) Money Management Basics 38

Try to use conservative figures. If you believe you are entitled to Working for Families check your entitlements and err on the lower side of what you might receive. Working out your expenses Fill in each row of the expenses budget that is applicable to you and your family - Use past receipts and bank statements to estimate future spending - If you have weekly, fortnightly or monthly figures multiply them to reach an annual total - Change the categories of expenses to fit with your own lifestyle or write comments as you go. Don t underestimate your spending on entertainment or leisure if records and receipts are hard to find. $100 per week x 52 = $5200 annual rent expense $45 per fortnight x 26 = $1,170 annual loan payments The more financial records you have the better, it is easy to forget annual costs or expenses from more than a few months ago, e.g. medical expenses, holidays, gifts and vehicle repairs/licensing. 39 Money Management Basics

Calculating a cash surplus or deficit Total Income less Total Expenses leaves a cash surplus or deficit. - Determining a surplus or deficit is a valuable step towards setting goals or making adjustments as necessary. Total Income ($61,110) - Total Expenses ($56,510) = Cash Surplus/Deficit ($1,890 surplus) What savings do you already have? Do you have a savings target? If so how much would you need to save each week, month or year to reach the target? Calculate this and be ready to include it in your budget. Money Management Basics 40

What to do with a cash surplus If you have a cash surplus left over once you ve paid for essential items, take away the temptation to spend everything you earn by paying yourself first. Just decide on an amount or a percentage of your income you re going to save each pay to improve your financial position. Put the extra money in a separate account and save it for emergencies or for a long-term goal such as buying your first herd, a house deposit, your children s education or retirement. Make a date to review your budget in six months time. It takes discipline to save over a long period, keep it simple, set realistic goals and watch your money grow. Saving is easier if you have some clear and motivating goals (eg. buying a herd) in mind. Remember while saving on a day to day basis seems to take forever, small amounts of money snow ball into large sums. What if I have a deficit? Use any savings to pay off debt Plan to pay off bad debt. Good debt can be used as leverage to make money (e.g. a loan to buy stock); bad debt on something such as a stereo won t help you achieve your financial goals Minimise the use of credit cards and hire purchase. Think about ways to increase your income What opportunities are there on or off-farm to earn more? In what areas could spending be reduced? A budget needs to be realistic or reductions in spending won t be achieved Keeping a record of what and when you spend in a notebook helps keep track of some of the miscellaneous spending that isn t clear on bank statements. Setting up separate accounts and using automatic payments is one way to ensure you are reaching your goals and preparing for future needs It is a good idea to put money aside for emergencies (two to three months pay) Set up a separate savings account for long-term goals Online banking accounts often don t have fees and without an ATM card it removes the temptation to delve into your savings to make an impulse purchase. For budget advice or to arrange a meeting with a budget adviser call 0508 BUDGET (0508 283 438). 41 Money Management Basics

Other budgeting tools You can use a range of tools and sources to help get started with budgeting and help to fine tune and monitor budgets on a regular basis. Getting started is the hardest part; once you have good records and systems in place budgeting will be a breeze. Develop your own budget Microsoft Excel is an excellent tool. You can develop cells for each month across the top and cells for each input item (income and FWEs and so on) down the side. Use the features of the spreadsheet to add columns and rows and do calculations needed to evaluate cashflow. Use commercial products Cashmanager RURAL helps farmers prepare, monitor and review their finances. Cashmanager allows you to record transactions, do monthly cashflows, GST, generate invoices, keep a wagebook, run reports for your bank manager, accountant and yourself to track profitability: crssoftware.co.nz BankLink is designed to reduce manual data entry. Transaction information is sent electronically from banks and other organisations to your accountant. BankLink data is easy to monitor, code against farm expenses and income, and may be used to generate cash reports and budgets. Bank budget templates - ask your banker if they have a template you may use. Your farm advisor or consultant may use software to assess the farm business, ask them if they have anything appropriate for budgeting. Ask your accountant if they have budget or financial recordkeeping templates that could be useful for you to use and may incorporate well with the systems in place at their practice. Potentially this could save you money if your accounts are in order when you hand them on. Refer to your Fonterra or co-operative website. For example the Fencepost fonterra.com website has a handy Payment Predictor in the Tools section (only accessible by Fonterra suppliers). Resources to help you budget DairyBase reports are extremely useful as you can see what you have spent historically and how this compares with benchmarks for your region: dairybase.co.nz The DairyNZ Economic Survey is published annually and contains tables of average farm financial data for the past decade. There is also a forecast section which may help indicate trends in the current season: dairynz.co.nz/economicsurvey Money Management Basics 42

Budgets - what next? Completing a budget and then filing it away is where the process breaks down for many farm businesses. Budgeting is an ongoing process, used to help make decisions for your farm business. To follow are a range of additional budgeting topics that may help you to better utilise budgets in your farm business. Managing a cash surplus or deficit Cash surplus If your budget indicates a cash surplus at the end of the financial year, you need to ask yourself how you will use this surplus. For example you may wish to explore options for investing back in your farm business, pay off debt or seek off-farm investment opportunities. These decisions should be made in line with your personal and business goals. A successful and profitable business will always set some guidelines for the cash surplus or profit they wish the business to deliver. You might like to calculate what return on investment your business is delivering to you. Cash deficit If you have a deficit, ask yourself some hard questions: 1. What is the major issue here lack of production and therefore income; farm working expenses too high; or the financial structure and funding of the business? 2. Do I need to make major or minor changes to make this budget work? Review your production level: 1. Focus on profitability, not production 2. Maximise pasture growth and utilisation for an average farm 30% pasture grown is not eaten by the cow vs. 15% on the best farms. Can you increase utilisation? Pay daily attention to pasture residuals and rotation length, which drive quality and quantity, which in turn drives production 3. Match the cows feed demand to pasture growth more closely appropriate stocking rate, calving date and rate, cow quality and performance (milksolids production at 80% liveweight), and pasture management. 43 Money Management Basics

Review your farm working expenses: 1. For big changes review your farm system and your feed, labour and fertiliser inputs what can you do to control costs, what system would deliver your best profit. Focus on profitability, not production 2. Review and update on the principles of profitable pasture based farm systems many NZ dairy farmers have forgotten how to use our most cost effective food source of grass, as they have learned to feed more expensive supplements 3. Examine your expenditure again eliminate discretionary spending, particularly spending on feed and fertiliser. For smaller changes look at all other costs and question every item of expenditure. Focus on financial structure 1. Is your balance sheet resilient and sustainable over the medium to long term? a. Yes formulate a plan and war budget to manage in the short term as above b. No structural issues need to be addressed i. Do you have any poor performing or non-income producing assets which could be realised? ii. Do you have an opportunity to introduce equity perhaps a family member or outside investor is interested in investing. iii. Could you realise some productive assets? 2. Keep in touch with your bank manager and accountant. 3. Remember the more effort you put in, the more effort the bank will put in. It may be worthwhile to look back over your budgeting process; were your targets and forecasts for the season realistic? Were you conservative enough? Too conservative? When setting targets, base your figures on the last five years production or expenses, look at trends in your expenditure, talk to people-in-the-know and most of all make sure the numbers look realistic. Monitoring and updating budgets Budgets are management tools and should be reviewed at least every two months to monitor actual income and expenses against what was forecast. Planning and monitoring allows you to be more pro-active and less reactive - to concentrate more on fire prevention rather than on fire fighting. When reviewing and updating budgets, assess the difference between the forecast and actual figures. Identify actions you need to take based on the variances: Is spending getting out of control in any areas? Was income higher than anticipated? Will higher income affect your working capital/overdraft needs? Feed, fertiliser, wages and repairs and maintenance are generally the biggest components of expenditure. Go through past budgets and highlight the major expenses. Could you make any changes? Whilst monitoring performance is absolutely essential, trying to focus on all measures can be distracting. Money Management Basics 44

There are key times to review and update your budgets: 1. During the season (at least every two months) or when changes occur: a. Milk income - keep up-to-date with commentary on milk income announcements and gauge whether it is anticipated to change again during the season favourably or otherwise. b. Expense cost variations, e.g. fuel price increases or feed costs change from budget c. Major un-planned expenditure (new tractors etc) d. Unexpected changes to production (drought, flood, etc). 2. At the end of the season a. Compare actual and forecast figures b. Provides information for forecasting/preparing budgets for the next season. Cost effective expenditure is not a slash and burn approach. It is about careful planning and setting farm policies to ensure you get value for money, reach targeted production and keep costs low on a per kilogram of milksolids basis. Remember to keep the focus on profitability and increased productivity. Remember FWE are correlated to milk income, so when milk income increases FWE increase as well. If you adjust your budget for milk income changes then consider how FWE may be affected, particularly feed. What if Once you have completed a budget, it is useful to look at how sensitive your forecast is to changes. Carry out some what if scenarios. Situations may arise that will impact on your cash position or bottom line. What would happen if: Your production decreases by 5% or 10% due to drought Milk income drops by 5% Expenses spike (e.g. fertiliser costs increase by 15%) Running sensitivity scenarios allows you to gain a clear picture of how exposed your cash position is to risk. It can equip you with the skills to review your budget to ensure you will be able to meet goals and targets, even when unexpected situations arise. 45 Money Management Basics

Engaging staff and other stakeholders Working in a business inevitably means working with other people who will have direct and indirect influences on how your business performs and how well (or poorly) you are able to stick to your budget and achieve business goals. Engage your staff and other key stakeholders in relevant parts of your budgeting process. Be transparent about expenditure levels and involve staff by asking for ideas on how to make cost-effective decisions. It may be useful to develop a farm finance policy that staff have access to and ensure they understand spending decisions and desired outcomes. Benchmarking Annual accounts can be of much more use than calculating the income tax position of the business. A wellprepared set of annual accounts provides a huge amount of information about the business. The accounts will also clearly and accurately detail the profitability of the business. Benchmarking is useful as it can highlight areas of a business that need to be focused on to improve profitability. Benchmarking within the business over several years is just as useful as comparing yourself to other businesses. Get involved in benchmarking your business by using a tool such as DairyBase. DairyBase uses your annual accounts to produce reports for the farm business, allowing you to monitor and benchmark your business performance. Contact your accountant, rural professional DairyNZ Consulting Officer or visit dairybase.co.nz to find out more. Need more If you d like to get the most out of your budget and set direction for your business, there are several courses available: DairyNZ Mark and Measure Courses (Business Performance, Strategic Management) run every year in May and June. See www.dairynz.co.nz for more details. Icehouse Agribusiness Program. See theicehouse.co.nz for more details Rabobank Executive Development Program. See rabobank.co.nz/rural/education/pages/education. aspx for more details BNZ Farm First Growth Program. See farmfirst.co.nz for more details. Money Management Basics 46

Glossary Asset Turnover % Dairy Gross Farm Revenue as a percentage of Opening Dairy Assets. The rate of asset turnover measures how well a farm generates dairy revenue from its assets. Benchmark A reference point against which to measure something and compare performance. Budget (1) An itemised summary of expected income and expenditure over a specified period. Budget (2) Economical or inexpensive. Capital expenditure Purchases of capital items such as fixed assets (land, machinery, plant & buildings) and investments (including cooperative shares). Capital transactions Purchases less sales of capital items such as fixed assets (land, machinery, plant & buildings) and investments (including cooperative shares). Cash deficit Cash expenses are greater than cash revenue (income). Cash surplus The cash surplus from farming operations over the year. It is the cash income generated, minus the cash expenses of farm working expenses, rent, interest, tax, drawings, net capital transactions, and net debt. In other words, it is the cash left over after all the bills are paid. Cash operating surplus Net Cash Income less Farm Working Expenses. It is the cash available from dairying after paying for farm working expenses only. Cashflow budget A financial budget showing expected income, expenses, the resulting surplus or deficit and bank balance over a given time period. It is most commonly prepared annually, showing the cashflow on a monthly basis for 12 months, and is updated and monitored monthly. Closing balance The closing bank balance is calculated monthly by taking the closing balance of the previous month and adding the cash surplus or deficit for the current month. For example, the closing bank balance for August equals the closing bank balance for July plus the cash surplus/deficit for August. 47 Money Management Basics

Dairy Assets The assets used to generate dairy income e.g. land, plant, machinery, stock, dairy shares, etc. DairyBase DairyBase is the industry s web-based system for recording and standardising annual farm physical and financial information. The aim of DairyBase is to lift the use of financial benchmarking in the dairy industry by providing clearly defined and readily available performance data through a set of comprehensive reports. Value is added through the analysis and interpretation of results which allow for fact-based management decisions to be made on-farm. See dairybase.co.nz. DairyNZ Economic Survey Annual survey of dairy farm financial performance with analysis of trends over time and historical financial tables, for owner operators and sharemilkers. Dairy Operating Profit A measure of dairy farm profitability. The calculation is Dairy Gross Farm Revenue (GFR) less Total Dairy Operating Expenses. It is the dairy operating return after an allowance for the value of change in dairy livestock numbers, non-paid labour and management, supplementary feed inventory change, owned run-off adjustment and depreciation. Debt A debt is money that is owed. Another name for a debt is a liability. Debt to Assets % Closing Total Liabilities as a percentage of Closing Total Assets. This measures the proportion of the business value that is borrowed by the owners. Distributable Profit The total profit from Fonterra s business activities available for distribution to farmer shareholders by way of dividend. Dividend The amount of Distributable Profit actually paid to farmer shareholders in respect of any financial year. Usually this is expressed on a cents per share basis. (Value Return was previously used to describe the amount of Distributable Profit paid out to farmer share, on a cents per kgms basis. This term is no longer relevant as profit is now being distributed via dividend payments). Drawings Household cash expenditure, e.g. living expenses, overseas holidays, donations, life insurance and private portion of farm cash expenditure. Economic Farm Surplus (EFS) A measure of farm profitability and is now referred to as Operating Profit. Equity The difference between what you own and what you owe i.e. your net worth. Farm Working Expenses (FWE) Total dairy farm cash expenditure, including labour, stock,feed, other working expenses and overheads. Money Management Basics 48

Funds introduced An injection of cash from sources that are not required to be paid back, e.g. inheritance, one-off relief payments for damage caused by adverse weather events such as floods, or any other non-taxable off-farm income. Forecast A forecast in certain contexts means the same as a budget. A forecast more commonly means to calculate or estimate in advance income, revenues, production and costs. Leverage Borrowing money for investment/s, leverage is also known as gearing. Milk Price The price paid to farmer shareholders for milk supplied to Fonterra, on a cents per kilogram of milksolids basis. Monthly cashflow A financial budget showing expected income, expenses, surpluses, deficits and bank balances over time that is usually prepared annually, showing monthly periods. Actual income and expenses can be compared against originally budgeted figures. Net Borrowings Increased loans or debt. Net Debt is the debt repaid during the season less the increase in borrowings (increased debt) during the season. Net Income equalisation The income equalisation scheme allows farmers who are eligible taxpayers to even out fluctuations in income by spreading their gross income from year to year. Net income equalisation payments during the year are calculated by taking the income equalisation balance at close less the income equalisation balance at open. Net Non Dairy Cash Income Total cash income generated from farm assets that are not dairy related less total non-dairy farm expenses. These might include revenue from wool, velvet, firewood, metal royalties, orchard products, viticulture, or forestry harvest. It also includes large one-off revenue items such as one-off forestry harvests. Net Off-farm Cash Income Off-farm cash income less off-farm cash expenses. Opening balance Opening bank balance at the start of the season for farm operations. Operating expenses Total dairy operating expenses, including cash and non cash items. Operating profit margin % Dairy operating profit as a percentage of dairy gross farm revenue. This measures the percentage of the revenue which is profit. 49 Money Management Basics

Overdraft An overdraft is an extension of credit from the bank, during the season as cash flows in and out of the farm business an overdraft may be required to continue operating. Payout The payment that farmers receive for kg milksolids produced. Principal The original amount of a debt on which interest is calculated. Quick Cash Budget A simplified financial budget showing expected cash income and expenses (with no farm working expenses detailed) for one season. Retentions The amount of Distributable Profit that is not paid to farmer shareholders, and is retained within Fonterra s balance sheet. Return on Assets % (RoA%) Operating Profit (whole business) plus owned run-off adjustment less rent as a percentage of Opening Assets. The RoA measures the profit generated from all the assets employed in the business, and expresses it as a percentage return. Return on Dairy Assets % (RoDA%) Dairy operating profit plus owned run-off adjustment less rent as a percentage of opening dairy assets. The RoDA measures the profit generated from the dairy assets employed and expresses it as a percentage return. Return on Equity (ROE) % (excluding change in capital value) Total operating profit plus owned run-off adjustment plus net off- farm income less rent less interest as a percentage of opening equity. The RoE measures the return on the funds of the owner but does not include the change in capital value. Strategic management The process around developing a vision of what you want your life to be like and the principles you want to live by. This is combined with the development of strategies and actions taken to lead you towards achieving that vision. Stock reconciliation Stock numbers for a given season, including the category of stock, those born, bought, sold or which die. Total return on assets % (TROA%) Total operating profit [plus owned run-off adjustment] less rent plus change in capital value divided by opening total assets. The TRoA is the profit generated by the assets employed plus capital gains and losses. It measures the overall financial performance of the business. Working capital The amount of money that a farm business has available to conduct its day-to-day activities. Money Management Basics 50

Notes / calculations... 51 Money Management Basics

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