Transcript

3 Baron-Hay Court, South Perth Western Australia 6151Telephone: +61 (0)8 9368 3333 Fax: +61 (0)8 9474 2405Email: enquiries@dpird.wa.gov.au

Financial intelligence webinar 4: Short term financial decisionsIn the audio is:

Doug Watson, Consultant, Australian Facilitation Company

Transcript

Doug Watson:

Good morning everyone. Welcome to webinar four in the Department of Primary Industries and Regional Development's Financial Intelligence webinar series. It will also help this time around, as per my sort of opening the written comments, that if you have your notes for webinar four, and the homework for webinar four available to you, as we will be referring to them as we go through the webinar itself.

Let's just recap where we are in this series of four webinars. Only one to go after this one. And we started by making sure that we understand some of our financial basics, and that we have quality information feeding into our decision making. And that was in the form of three financial statements: a profit and loss, a balance sheet and a cashflow. And whilst you might have been familiar with the cashflow, the profit and loss and balance sheet may have been reasonably new concepts to get a grasp upon. But they help identify the overall financial health of the business, and the strengths and weaknesses once we start to look at some ratios. And we spent quite a bit of time in webinar three looking at the profit and loss and cost of production.

In webinar two, we looked at those financial health check, if you like. And the financial ratios, especially around the medium to long term situation of your farm trying to head towards sustainably growing the wealth of the owners, the equity portion of the balance sheet, and it’s profit that will grow that equity portion. And we finished up webinar two by looking at, well what do we do with profits? Do we leave it in the business and reduce debt? Invest in things? Do we take it out of the business, off- farm investments, preparing for retirement, rewarding the owners for the risk they have taken? And how do we get that balance sort of right? And having set those longer term sort of objectives of sustainably growing the owners' wealth, making those decisions about what we're doing with the profit in each year, as heading toward those longer term sort of goals that we have.

And last week, we looked at those medium term financial decisions, maybe those financial decisions that span operating cycles. Maybe they're a one to three years sort of thing. Depends on the cycles within your farm. And we looked at cost of production and the decisions we make about revenue, and overheads in particular can take that one to three years to have a real impact. Well, we need to optimize them over that time, rather than just optimize them in one new year, which might mean they blow out the next year. So we need to look in that medium term horizon to make sure that the decisions we're making fit in with the longer term goals that we're actually setting.

So this webinar is actually focused on short term financial decisions and making sure they fit in with the medium term and the longer term. So the decisions we make within a season, to try and get the most out of a season. So we're going to focus on the variable costs. So you may remember last week, we talked about a little rule of thumb in terms of improving the financial performance in your profit and loss. And I think we call it the 6-1-5 rule. Thanks very much Daniel. He's audio/ video is working. Good to see you on board. We talked about the 6-1-5 rule and increasing our revenue by six percent, reducing our variable cost by one percent of our turnover or revenue, and reducing our overheads by five percent.

And last week we looked at options for the revenue and the overheads, as they are medium term type decisions. Our variable cost decisions are largely in the here and now, in the short term. So we're going to be looking at the one percent. How can we reduce our variable cost by one percent of our revenues? And not one percent of our variable costs, but by a ratio of one percent of our revenue, and making sure that fits in with our medium and longer term decisions. So we've got three broad outcomes.

Or, sorry, webinar five, next week, we'll be looking at managing financial risk, which covers all three time horizons and making sure that we're growing the owners' wealth sustainably. I guess we could take a lot of risks, but that may not be sustainable. So managing financial risks is next week. So we’ve got three broad outcomes that we're looking to get from this week's webinar. And the first one is around understanding those variable costs and margins.

And you may remember from webinar one, that our margin is our revenue minus our variable costs. So the costs that go up and down with how busy with are, the variable costs, how much we're producing, they go up and down. And we take that away from our revenue. And that gives us a gross margin. And from gross margins, we take overheads, and that leaves us with an operating profit before tax, earnings before interest and tax, and drawings, if you like. EBIT, is what we've referred to.

So variable costs and margins can be impacted by short term decisions around productivity. And we'll define productivity in a minute. It's about being more efficient in your farming operations, to get the most, biggest “bang for your buck", if you like.

And increased productivity, here's our definition, is about improving the ratio of inputs to outputs. That's an important definition because it gives you a range of options to be more efficient and more productive. It's not just about generating more revenue or cutting costs. There are other things we can do. And we'll define those in a minute when we get into the webinar. And just to point out there may be a typo in your slides. Instead of [inaudible 00:05:49], I think it says [inaudible 00:05:50]. So I've changed it in my slides there.

And the last one is, "Is the banker [inaudible 00:05:56] me?" Here's an old saying that accountants have, and even bankers have. You know, "Income is vanity. Profit is sanity. Cash is reality." You can't change cash. And in webinar one, we looked at these notional entries we made up to match revenue with expenses. Changes in our inventory levels and our stocking levels, and also the timing and receipts of payments and making payments. And we made up entries to match revenue with expenses.

Importantly, when we are doing that, our balance sheet and our profit and loss change. But what doesn't change is your cashflow. Cash is reality. You cannot change how much money you have in the bank. You've got to sell more stuff. You've got to collect the money before it's worth anything. So cash is that reality. And if we don't have enough cash, we can't pay the bills. And banks are very interested in that part of the equation.

So whilst profit is important for those medium term decisions, and will retain your sanity, maybe we may be better off actually making less sales but more profit and be in a better cash position. And that's a challenging concept in terms of we generally accept, "No, no, it's about more revenue." But maybe revenue isn't the important bit. It's about the balance between revenue, costs, and the cash that that helps generate. I've done quite a bit of work with news agents in the past. And believe it or not, they make about eight percent on a lotto ticket. So on a $10 lotto ticket, they're making 80 cents. But if they sell a chocolate bar for $3, they're making a $1.50. So the margin on chocolate bars is a lot better than on lotto tickets.

The success of a news agent is about how many chocolate bars, magazines, pens they sell, not how many lotto tickets they sell. And in fact, they might be better off selling less lotto tickets and more of the others. And that is, their income goes down, but their profit and cash position is actually improved. Have a think about your farm and whilst revenue is generally accepted as, "[inaudible 00:08:09] the more profit," that may not always be the case. So have a think about that and how you can be more profitable rather than have more revenue.

Okay, so let's get into the content for this week's webinar. Now we've looked at the learning outcomes, and we've positioned things. And we have looked at benchmarks before. And I guess we need to take some benchmarks with a grain of salt. And we talked about benchmarking yourself, rather than to others. But as a starting point, and as a slide, and to highlight a certain point, I've included some information from Bankwest's benchmarks in their Planfarm website. And there's a link to this provided in your references. And this is for MRS 3 rainfall, a bit of an average, I guess, rainfall sort of area. And it's a whole-of-farm identification of the variable costs involved in this particular farm.

So I haven't put it up there to say, "This is what your cost should be." I've put it up there to show a couple of key points. A) The nature of variable costs. Fertilizers, crop protection, grain handling and levies, cartage, even repairs and maintenance. The busier you are, maybe the more repairs and maintenance you actually need, et cetera.

And the second thing I want to show is that if you look at the top four, the top three or four variable costs generally account for 60 to 70 percent of all of your variable costs. So if we look at the top four here: fertilizer, crop protection, grain handling, repairs and maintenance. It actually adds up to about 67.6 percent. So just under that 70 percent. And the reason I highlight that is that this is a good place to start in terms of managing your variable costs, to look at the big ticket items. If only three or four are covering 60 to 70 percent of all of your costs, then the most gains you're going to make are on those big ticket items. And a reminder, the variable costs, the costs that go up and down with how busy you are. So it may be the amount, the cost of seed if you plant more hectares. Or the cost of shearing, if you shear more sheep. If you have more sheep. So generally, fertilizer will go up and down with how much you plant in terms of hectares and/or the nature of the crop. So it's not a direct relationship, but it's a general sort of relationship.

So my question to you is to think about your farm, which may not be exactly the same as these benchmarks. But what are your top three or four? How do they compare to other similar farms? How do they compare to the past? What you've been doing in the past? What should they be in the future, if you were to optimize your costs? And optimizing is about a balance between the revenue it helps you generate and the costs that you're actually incurring. Are you trying to sell more lotto tickets, but only making eight percent when maybe you should be thinking about the chocolate bars, to a degree? A very city boy sort of analogy, but that's the best I can do.

So what are your top three to four costs? There's a good place to actually start in terms of analysing your variable costs. And the sort of decisions you can make around your variable costs once you have a good handle on them and understand them quite well. And hopefully at the end of this webinar, you'll be thinking seriously about some of these decisions together with your cost of production. Variable costs feed into your enterprise mix. Now, it's a financial consideration that you add to the environment, the marketplace, and farming issues. But it's an important consideration to get the right balance and mix right, for the medium to longer term. So think about your variable costs as feeding into that enterprise mix type decisions.

Variable costs are quite important within the season, of making these "what if" type decisions, the so-called "sensitivity analysis", if you like. So there's an example in the PowerPoint there. And we give you a scenario where canola sells at 500 a tonne. And you're expecting a yield of two tonnes a hectare and your variable costs of 550 a hectare.

So at the start of a season, we might be thinking, "Well how much do we plant of canola? Should we plant extra? Should we plant less? Should we change our mix within the enterprises that we have on the farm? What would be the impact if prices were to go up by five percent, if our yield was five percent better, and ... or there was a reduction of five percent in our variable costs. So we can change any one of those criteria because our original estimate says 500 a tonne, times two tonnes a hectare, minus the 550 variable costs, means we'd be making a gross margin ... that is our revenue minus our variable costs per hectare ... of 450 for the canola.

But if price went up by five percent, instead of getting 500, we're getting 525 for our per tonne for canola. We multiply by the two tonnes because the yield hasn't changed. And we take away the 550 of variable costs. And now we're making $500 a hectare for our canola.

What if yield was five percent better? So we may not be able to control price but we might have a feel that we're being particularly conservative in that price, and that there is an upside. But maybe if we invested a little bit more or changed things around, we might be able to improve our yield. So in this case, the 500 a tonne, the price remains the same. But our yield goes up to five percent to 2.1 tonnes per hectare. If we take away our $550 variable cost per hectare, we end up with 500. So a similar result with yield and price. And both of those are $50 better per hectare than our original estimate.

So to get a five percent improvement in yield, if it was costing us $10 a hectare to do that, and there was an 80 or 90 percent chance of getting an improvement in our yield of five percent, at 10 percent improvement in our variable costs, or increase in our variable cost to ... would be taking our variable cost from 550 to 605. So we'd have to stop and think, "Well, is it really worth a 10 percent improvement in our variable cost, to improve our yield by five percent?"

So you can sort of see the decisions we're making. And the last one is around our variable costs. And if we were to reduce those by five percent, our original estimate of 500 a tonne, times two tonnes per hectare. And then we take off the increase in our variable costs. And I can see we've actually got those numbers around the wrong way there. So there's a bit of a typo there, which I'll have to fix up as ... No, actually they are correct. So it goes from 550 down to 522.50. Take the five percent off our variable costs, and you can see that we're at 477.50 per hectare, which is $27.50 better per hectare than our original estimate. But it's not the $50 better in our yield and our price.

So our short term decisions around price and yield will have a, generally, a bigger impact than in variable costs. But there's a lot more chance involved in price and yield. Whereas, if we can control our variable costs, there's a lot more certainty. If we can make that five percent cheaper with a 90 percent certainty, I don't know that we can get 90 percent certain about price and yield. So whilst it seems as if they're not as important, I think if we take into account risk, which we'll be looking at next week, you can see that ... I don't know. I'm not one to go to the casino too much, but 100 percent chance of getting a $27.50 improvement might be better than a 30 or 40 percent chance of getting a $50 improvement. I think the key is to maybe focus on all three of these, and go, "How do I maximize the price? How do I get a better yield? But how do I control my variable costs?" So they're the three decisions that we're considering in our short term type decisions.

And the last sort of decision we might want to make around variable costs have to do with the amount of working capital we need. And you may remember from webinar two, the ratio of working capital was, we take our current assets and we take away our current liabilities. Current assets turned into cash in the next 12 months, and current liabilities need to be paid in the next 12 months. So the big one here is we need to fund that working capital because we may not have the cash to actually do it. And that means going to the bank and increasing our overdraft if we don't have the reserves to cover that. So if wanted to put in an extra 500 hectares of canola, and that's costing us in variable costs an extra $100 a tonne, compared to wheat. Then the 500 hectares times the $100 a tonne is $50,000 more working capital is required.

Now we have to work that into our financial calculations. Because to borrow 50,000 for, let's say nine months of the year, and let's say ... Let's keep it simple and make it 10 percent of 50 is five grand. For nine months of the year, three-quarters of five, yeah 3,750. Somewhere around there. So is it going to generate and cover that extra interest? Do I have access to that extra capacity to borrow the 50,000 sort of decisions we start to try and make around our variable costs.

And just a reminder around variable costs, we're just looking in the short term. We're not looking in the medium or longer term, and we're not thinking about overheads. So we're not talking about profit here. We're talking about short term decisions. We need to think about the whole of farm, as well as enterprise variable costs. And there are some issues in just focusing on a single season rather than on multiple seasons to try and optimize our profit. But in the short term, decisions around variable costs are very important. Especially to do with our bank balance.

So I'm going to take a bit of a breather there because I've been talking for a while. I'll have a sip of water. Any questions anyone has so far around variable costs and the sorts of decisions you can make, and the sorts of costs we're actually talking about? I'll give you a minute to actually type.

(silence)

Can't see anyone typing at this point in time, so we'll continue on and have a look at our next slide here. Now, I've previously said that to make good decisions around variable costs, you need to understand how they behave. So I think some variable costs are catalysts to a good outcome, a good price and a good yield. They promote the positive: fertilizer, seeding, right? That sort of thing. Some variable costs are dependent upon your yield and how much you actually produce. So they'll go up and down with ... And maybe freight is a really good example of this. And if you are involved in marketing expenses and levies and that sort of thing.

Some variable costs are sort of independent. We spend money on them, hoping that they will drive more volume. But there may not be any guarantees. And some variable costs affect yield quite directly. They're like an insurance. And they affect it by avoiding the negative. And you can see some of the examples, actually, there. So the relationship's not always straightforward because we've been saying variable costs have a relationship to your volumes of outcomes. Tonnes, kilos, that sort of thing. But in effect, the relationship is more aligned to yield than it is directly to outcomes. And understanding that in terms of your risk profile and in terms of making the decisions that you make can be quite important.

How much you spend on these sorts of things, really coming back to farming decisions and the quality of farming decisions that you make, and working with partners like your farm consultants to work out the optimum level. Maybe not the most that will get the absolute best outcome, because you might be overspending. So we don't want to overspend, and we don't want to underspend. Just like Goldilocks, get it "just right" in the middle somehow. And that is an art, in doing that. So think about the variable costs, and the nature of those variable costs. Not just that they go up and down with your volumes of production, but also in that they do that by impacting yield or being impacted by yield.

Now we said that efficiency and improving our variable costs through efficiency and productivity has to do with ... There's five different ways that you can actually do it. Let me just go through them one by one. And most people start with, "What if I produce more and spend less?" The old "more with less". But there's about four other different ways that you can actually do it. Sometimes we need to invest. We need to spend more to improve the chances of getting more in outcomes. And as long as the more outputs are larger than the inputs, we are being more efficient, and we've improved our ratio. We could also be more efficient by using the same amount of inputs and getting more outputs. And that will improve the ratio between inputs and outputs. With the same amount of fertilizer, with the same amount of insecticide, we're getting more outcomes. Here, we're talking about maybe investing more in the size of our flock. And as long as that investment drives more outputs then we actually invested, then we're going to be better off.

Sometimes we can be more profitable by spending less, as long as the amount we spend, or the inputs ... and largely we're talking about dollars and converting those into dollars ... that the inputs or costs, or cash outflows, are larger ... the reduction is larger than the reduction in our outcomes. So sometimes, it's about focusing our efforts and concentrating where we're spending our time and effort and energy. And this might involve spending less and producing a bit less. But as long as we're saving 50,000 and our revenue is only dropping 10,000, then we're going to be 40,000 better off. So are there some really inefficient areas of your business here?

And definitely we want to reduce waste. And this is a key one for us. If we can spend less, but get the same in terms of the production and revenue, then we're going to be more efficient. And the most common one people do is a combination of all of these, where they aim to spend less on the variable costs, but achieve more in terms of outcomes. And this may not always be possible, but it might be the goal that people sort of start with. And the reason people start with this goal is that it builds in a contingency plan that is, "If I end up spending less, but I don't achieve more in outcomes, I'm still going to be better off. If I achieve more in outcomes, but I haven't spent less, I've spent the same, I'm still going to be better off." So this might be the one you aim for, but you might end up with one of these in the end result.

So it's an interesting way to look at your inputs into the farm, and the outputs from the farm, to try and make sure that you are optimizing your variable costs that are going into it. And maybe even building in some contingencies by not putting all your eggs in one basket, putting them in a few different baskets. So this is a way that we need to look at reducing our variable costs by that one percent of our revenue.

So ... just a problem with my ... Technology problem here at this end. So my slides have disappeared. I'll just get them back up. Just bear with me. (silence) So whilst I'm just getting those slides up, if anyone has any other questions, please type them in now. My apologies then, I just knocked a cord and the PowerPoint disappeared, so it's just coming back up. (silence) No questions? (silence) There we go. I think normal transmission has been resumed. Or as normal as I get. So I think that's the slide we were looking at before I rudely interrupted things.

So this is how we're going to look into try and reduce our variable cost by that one percent of our revenue. And I want to focus a little bit more on that reducing wastes. And this is where your homework will come in handy. So if you have your homework actually with you, there's a lot more detail provided in the homework because we start to move into areas that are more farming related than finance related. Because in the end, it is these farming decisions which are going to reduce the variable costs that you have.

Now, there's a philosophy in Japan about continuous improvement called kaizen. And it has to do with the seven wastes involved in any business. So what I've done is, I've taken those wastes and abbreviated them to five to end up with some headings. And those headings are in your homework there, about some options you have in terms of trying to reduce your variable costs.

So you can see the first one there is getting the timing right. So this has to do with you being proactive and you planning things up front, such that you can address issues as and when they arise. It's about avoiding waiting and downtime and delays because you've planned and been proactive up front. And you can see some farming examples in your homework. And in your homework, we're going to be asking you to say, "Well, which ones of these might actually help you in terms of reducing your variable costs? Do you do this well? Are you flexible enough? Are you focusing in on the 100 one percent improvements that you can make on the farm, rather than the two or three 20 or 30 percent improvements? Because it tends to be the cumulative effect of the small decisions you make that will have a big impact in terms of being more efficient and having those variable costs reduced.

So the second one we talk about is matching supply with demand. So what we're talking about here is avoiding things like double handling. We're avoiding things like too much labour on the farm, ordering too many chemicals. We're talking about the overspending and the underspending I mentioned before. And I guess things can be wasted if you have too much, or if you don't have enough, and you haven't bought in bulk, and you have to buy at short notice, that can be a waste as well. So spend some time matching how much you need with how much you're going to use, and the cost of doing that, and optimize that level of spending. So there's more specific details in your homework there.

Thirdly, and this might seem obvious, but mistakes cost money. So what can we do to try and avoid them? Now some mistakes are unavoidable, and there's nothing we can do. But there are some things, with a bit of thought beforehand, with a bit of training, with a bit of feedback, with a bit of avoiding some of those negative aspects we talked about in the nature of variable costs and yield, in terms of the use of insecticides and herbicides, fungicides and drenching and all those sorts of things. They're like an insurance policy to avoid mistakes, costly mistakes. But it goes broader than that, in terms of supervision, training, feedback, to staff and others working on the farm. So you've got some examples in your homework there.

Fourthly, optimize your resources. What is the best mix? So not what is the greatest income, what will drive the greatest income. But for each dollar I spend, what will give me the best return in terms of my gross margin? How do I improve that percentage of variable costs to revenue by lowering it? So it's about matching quality and volume with cost. It's about value for money. It's about maybe thinking about some of those things that promote the positive that we talked about, the variable costs that promote the positive in affecting yield. Fertilizer, seeding rates, the catalysts to a good outcome. And what is our optimal level?

And the last one we looked at is improving logistics. The use of technology, bulk buying, transportation, movement, some of those costs involved in the day-to-day operational logistics of the farm. And what can I do? And this will have a big impact, I guess, in terms of things like cartage and fuel and oil and those sorts of things.

So if you look at your homework activity, you'll also see that directly underneath that list of suggestions around those types of focuses to reduce your variable costs, we also have some specific suggestions around livestock, and also around cropping. So not really for me to get into. That's more about your own farming knowledge and expertise, and indeed working with consultants and trying to get that right. That's a real art and skill, I would imagine, to get that right.

So I might just give people a bit of a break there. We've been going, sort of according to my watch here, 36 minutes. So it might be good to stretch the legs, grab a cup of tea, go to the loo, whatever. And we're be back under way in five minutes.

Five minutes is up. Hopefully, people managed to grab a [inaudible 00:32:30] something. So yeah, any questions so far, before we head into the next section? Which is about, "Well, how do I monitor and see if I'm improving in my variable costs within the season? How do I monitor some of these short term decisions? So what we're going to look at here is a cashflow and some basic principles around preparing a good cashflow. And I'm aware that many people are probably more familiar with the cashflow than they were with the profit and loss and balance sheets, so we won't go into as much detail. We want to highlight some of the key principles in building a good cashflow, and monitoring that cashflow.

Your farming software and financial software will often be able to do this fairly well for you as well, so let's have a little look at some information around cashflow. So when we looked at our financial health check, we looked at the medium term, the long term, and some short term ratios. And our short term ratios tending to be something called a working capital ratio. You take your current assets and divide by your current liabilities, and that was called your working capital ratio.

Unfortunately, for a farm that is very seasonal in terms of its revenue and expenditure, its cash inflow and its cash outflow. This might not be the best way to judge your liquidity, your ability to pay your bills when they fall due. Perhaps a better way to do that, definitely a better way to do that, is to prepare a cashflow budget. And what I mean there is that's going to show you month by month what your position is, rather than just that one point in the year because our balance sheet is at one time of the year.

So we're going to get a bit of a handle on our cashflow. If we look at our liquidity, our ability to pay bills, if we look at a cashflow rather than ratios. And you may remember one of the goals we sort of talked about, potentially, in webinar two was, it would be lovely if our cashflow was positive during the year, so you ended up with more cash at the end than you did at the start. And it would also be very nice if you didn't need to use an overdraft, because then you wouldn't have to pay interest, if you had enough resources. And this might be a good contingency plan if there is a season that isn't as good as you thought it would be.

So we have the cash movement. The cash in, the cash out over a 12 month period month-by-month is a typical cashflow. And one of the things we need to take into account is obviously the seasonality of cash coming in and cash going out, as we do that. And what it will demonstrate is our ability to pay our bills when they fall due. And this is one of the reasons that a bank is very interested in your cashflow because one of your bills is to repay the interest and principal on your loans. So one of your cash outflows. The interest is an expense, will be in your profit and loss. The repayment, is actually a reduction in liability, will be in your balance sheets. So this repayment of your loans, whilst it's a cash outflow, is not wholly an expense. Unless your loan is interest-only. So interest-only will be an expense. But any repayments ... The other side of a repayment is a reduction in the amount that you owe, and also an increase in your expense, interest. Okay? So one of the differences, I guess, between profit and loss, and cashflow.

And we're going to determine our peak overdraft requirements, so that we can make sure we're operating within our means by using this cashflow. And we're going to also make sure that we've got enough money in the bank to pay our bills when they fall due. It will allow us to monitor the impact of our strategies around variable costs, by highlighting what did we plan to happen in our budget, compared to what did actually happen?

And that's the main reason you're preparing a budget. Not to keep the bank happy, albeit that's an important reason. The main reason you're preparing it is to check that what you thought was going to happen is actually happening. Because what that will allow you to do is, throughout the year, if things are going off track, “what do I do to get them back on track? This cost is too high." Or, alternatively, "This is going really well. This cost is a lot lower than what I actually planned. What do I do to continue this cost being lower, or this revenue being higher. “

So what that allows us to do is make decisions throughout the year that try and ensure that we end up, at the end of the year, with the result that we were aiming for. And it's too late when you get to the end of the year, to go back and we go, "I wish I had've done this," or, "I wish I had've done that." So our cashflow and comparing actuals to budget will allow us to make some of those calls during the year and make our best efforts to try and achieve our end of year result that we set out to do.

So let's look at a sample cashflow. So we have cash inflows, and on this particular farm, we're just looking at some broad headings rather than the detail. We've got some cash inflow from grain, from livestock, and some other form of income. And we've done it in thousands. And we've done it from March through to February. And you can see, maybe there's sort of a late grain payment or pool payment sort of coming in somewhere here. We've got our livestock and some peaks and troughs there. And we've got some random other income going up and down throughout the year. And that gives us a total inflow. I should be talking about cash inflows rather than income. Sorry. Income would refer to your profit and loss. Here we're talking about cash inflows. Two different things. Albeit though they may be reasonably closely aligned.

Our income will include timing differences, where we've sold something but we don't receive it until later. So if we sold something in February but don't receive it until March the next year, we would put it in as income, but it's not a cashflow. So remember, this is cash inflows, money that's hitting your bank account. And we've got some totals there. Grain, livestock, other. And a total inflow of cash. Then we've got some outflows. Crop, livestock, overheads. Now family drawings are definitely an outflow, but that may not be an expense, depending upon the structure of your farm, and whether it's a company, a partnership, a trust, a sole trader, et cetera. But they're definitely a cash outflow because we're not talking expenses here. We're talking about money coming out of your bank account, just like we're talking about cash inflows being money going into your bank account. So remember that there can be timing differences, and there can be changes in your tradable assets going up and down. And they are two of the big differences between your profit and loss, and your cashflow.

Also, your profit and loss doesn't include any cash inflow or outflow in relation to assets, liabilities, or equity. So here, we would include any cash inflows and outflows. So if we borrowed money from the bank, that would come in as a cash inflow. If we repay money to the bank, that's a cash outflow, even though it may not be an expense when we reduce the principal, just the interest is an expense. And similarly, family drawings is an outflow, but it may not be an expense. So just a brief summary of some of the differences between cash inflows and outflows.

So we got a whole bunch of different costs, or outflows, happening. And we've got some totals, month-by-month down at the bottom, just like we have totals in terms of our cash inflows at the top here. Some months with no cash inflow. We've got some total cash outflows. And you can see they all add up to 384, in terms of total outflows. And let's just complete our position here. Because if we've only got 337 coming in, and we've got 384 going out, we're going backwards 46.3. Which means if we started with 33,000 in the bank, we're going to end up 13,300 overdrawn.

So at face value, this cashflow is not good. It's going backwards. And you can see the peak month-by-month. So I would need to have access to, in this case, to allow for timing issues and differences, maybe a $150,000 overdraft. Because our peak position, as per these numbers, is 128,400. In doing this, and if I didn't have access to 150,000 maybe I’d need to rearrange the timing of some of the inflows and outflows, to try and reduce that peak [inaudible 00:42:05] by moving some of the outflows into other months, and bringing some revenues into some of the quieter months, if possible.

You can see though, that this cashflow does return to credit in two months of the year. 9.9 in December, and 23.4 in January, before it then ends up overdrawn, 13.3. And we started with 33,000 in the bank. Now I say, at face value, this is not a good cashflow because it's gone backwards. But if your long to medium term decisions were about investing in the farm and changing how you're doing things and spending more so that you can make more in the medium to long term, then in the short term, you may go backwards in your cash. For example, if you're building up your flock, and a lot of these livestock costs are related to a build-up in your flock, and you're not selling those sheep because they'll generate more for you in the future, in terms of wool, it may be quite a deliberate ploy to actually invest in the farm to make more. And this might be optimizing your profit and sustainably growing the owners' wealth in the longer term.

So hence why we need to be careful about making absolute judgements in terms of short term decisions and the cashflows that they may generate. You'll notice that there's no tax or GST here. I guess there's two options. You could either include GST in all of these figures, and then the payments and the BAS payments, and all that sort of thing. Generally, GST though is going to have a positive impact on your cashflow because you're holding on to the government's money before you send it to them. So this might be a worst case scenario, if you leave GST out.

And it might be simpler to leave GST out. There's no depreciation here because depreciation isn't a cashflow. It is a book entry. And we will define depreciation more in webinar five. But for the time being, depreciation is the allocation of the purchase price of an asset over its useful life. So if we purchased any assets, they would be in the cash outflows. But their depreciation is not. Hopefully that will make more sense, for those that are struggling with that concept, next week when we go into more detail. But just wanted to point that out as one of the major costs that's not reflected as a cash outflow. So hopefully people are reasonably familiar with that sort of format. And all the red and bracket numbers are obviously negatives because we've moved into overdraft. And the black numbers are the positives.

So any questions on the structure of a cashflow? Anything you might struggle with? I'll give people a minute or so while I take a drink. (silence) No one typing, so I think people are reasonably familiar with cashflow.

So let's look at the principles of generating a good, strong quality cashflow budget. And I guess that's the first thing we need to point out, is that it is a budget. So it is a guess. It's not meant to be 100 percent accurate. And in fact, if it is 100 percent accurate, then you're probably lying. Actually, some things you do know are going to happen might be 100 percent accurate. But as a banker, anyone who got really close in terms of their budget, I was very suspicious of. Because it doesn't work that way. It's a guess.

But let's try and make it as good a guess as we can. So there's a few key principles. And the first one is, the decisions you make and the assumptions you make to generate your cashflow, should align to your business plan, your farm plan, your overall plan, your long term, medium term plans. It should be a reflection, if you are going to change your rotation, change your enterprise mix, invest more, it should be reflected in your budget.

You've got two broad choices in terms of generating the figures in your budget. You can start from a blank piece of paper, a zero-based budget. Or you can look at last year's figures, add a bit on, take a bit off. Incremental budget. The problem with an incremental budget is it doesn't challenge you to work out whether last year was an optimum expenditure or not. So we might be perpetuating past problems, which is very hard to say early in the morning. We might be including errors that we made last year, or inefficiencies, just by taking last year's figures and adding a bit on, taking a bit off.

For many of your smaller expenses, this may not be a bad way to do things because it's not going to have a big impact on your budget in the end. And it might be quickest to do it that way. But for some of your major expenditures, so I'm going to suggest those top three or four variable costs. Go back to basics and go, "How much do we need to spend, to get the outcome we're looking for? The best outcome? The best quality? The best value?" So it may not be the biggest, but the best. So go back to basics in that, and how do I get that cost down? Would it help if I bought in bulk? If I knew that that was the amount that I needed?

We need to get the timing right, in terms of our budget. So we want to set the budget well in time for the new farming year. We don't want to be setting it in May and June, when the farming year started back in February, March. The horse has bolted. We haven't planned things. We're playing catch up. So we should be spending time and getting it ready. And part of that process and the time that you spend is about consulting with other people. So your notes for this unit, webinar four, will contain a bit more information on each one of these dot points. We need to consult with our off-farm experts, and also people within the farm, as to their input into the budget. It helps in terms of accuracy. It helps in terms of getting buy-in and commitment to a budget.

Second step is around your assumptions. And the essence of a good budget is about the quality of your assumptions. So whenever I see a budget, one of the first questions I ask is, "Well what are the assumptions?" And you can't publish a budget without those assumptions going with it. Otherwise, it's just a bunch of numbers on a page. But if you tell me where the numbers have come from, and the assumptions you've made to get them, then it gives me a sense of the quality of the budget. So we're going to talk about this in the next slide a bit more. But we've so far used past results, maybe last three years average. We definitely want to be conservative in terms of these figures. We want to maybe build in some contingencies by being conservative, and allowing a little bit of a margin of error, if you like. But we need to understand the constraints we're operating within as well. Financial constraints. Farming constraints. Labour. Manpower. Management constraints. And make sure that our assumptions recognize those as we make them.

Thirdly, we need to be good at the mechanics and build the forecast. And often, a template or our software will build this for us. And we build it at levels, and we need to think about the different levels we build at, the level of detail we're actually going into. As we're doing that, it helps us identify the sensitivities as we ask these "what if" type questions from an earlier slide. "What if I spent a bit less there? What would the impact be? Would it save me money in the end?" And this helps us identify the key success factors that are underpinning the budget.

And as we're building the forecast, we need to check that it's accurate. And this might involve some of the formulas, if we're using a spreadsheet. Some of the addition, some of the transposition of numbers and figures, such that we don't end up with a wildly inaccurate budget. And the last thing we need to do is implement it. And we're going to talk about this in another slide in a minute. I guess you can have the best budget in the world, but if you don't implement it, if you don't check what you said was going to happen to what actually did happen, if you don't take action as a result of that, then the budget is meaningless. If you're just producing it to keep the bank happy, you're wasting a lot of time and effort. Because you've got some really good information here to help you manage the farm month-to-month.

So be conservative. Use your software to its advantage. Refer to some of the notes that I've actually talked about. Base your budget on a farming year rather than a tax year. And apply some of these principles to try and get the best quality estimate that you can. And this will allow you to make good decisions as you go through.

So I talked about the quality of a budget is about the quality of its assumptions. And assumptions can fall into three broad categories. The stuff you know is going to happen. This is where we've got 100 percent certainty. We know our loan repayments. We know how much we need to live, in terms of our drawings. We know our starting points. We know our business plan. We're going to look pretty silly if we don't build in the stuff we knew was going to happen into our guess of what's going to happen. So build in the stuff you know is going to happen with 100 percent certainty. Estimate the stuff that you know is going to happen, but you don't know to what extent. And this is where the guesswork comes in. Educated guess, not random guess. Show me the rationale behind each one these. And make sure it's conservative, and it's realistic, and it's doable.

It may be a stretch in some cases, but make sure it's a line back to your business plan. What are your estimated commodity prices? Use futures. Use what the bank might estimate. Have you allowed for inflation? Banks are very good at setting fixed rates for loans, and fixed rates are an average of what they think the variable rates will be over that time period. So what is the fixed rate for the next 12 months? Might give you an indication of what the variable rate is doing over that 12 months. Estimate your seasonal conditions, and your yields, and your farm plan, and the impact upon those yields. Maybe look at long range weather forecasts. Definitely look at your historical information. And base some of your estimates on those.

Thirdly, there's going to be stuff happen that you didn't know. They come out of the blue. There may be health issues on the farm. A global financial crisis may hit. This trade war sort of happening in the moment, who knows what that may impact in the short term? Maybe decisions of farmers around you can impact on you to some degree as well. And I guess this is what we have contingencies for. Just in case. Or the other alternative is, "Well, I'll deal with them if and when they happen." So they can be a real risk, in terms of budgeting, that you've taken too far and planned to the -nth degree, and worry about stuff that may or may not happen. At some point, you've got to draw the line and say, "You know what? I'll deal with that if and when it happens, in the best way that I can. I've planned as much as I can." So don't get trapped in that procrastinating over too much, and planning too much. Get the basics right. Allow for some contingencies. And then deal with them if and when they may happen.

Now the main thing I said about a budget in terms of value to you, is about comparing the actual figures to what you planned to happen. So this is covered in your notes as well. And these dot points are expanded a little bit in the notes for this section. But you can see some of the headings there. Some people have the temptation of, "Well, we're well off track with the budget. We'll just change it." Uh-uh. The whole point of a budget is you have discipline. And you are striving to achieve it. If you just change it because you're not achieving it, it takes away that discipline. What some people do, if they're well away from the budget, or well in front or well behind, is that they forecast where they end up at the end of the year, if they remain this far ahead or behind. And that can help them make decisions in terms of pre-empting things.

But generally, don't change the budget. Change your forecast, which is a prediction of where you'll end up, now that we're three months into the season. But don't change your budget. It takes away the very point of having one, and something to strive towards.

When I'm analysing a budget, I tend to look at the totals before I look at the subtotals. I look at year-to-date before I look at the month. And what this does, is it allows me to get a sense of what's going well and what's not going well from a big picture perspective before I look at the detail. If you do a budget line-by-line and have lots of lines in your budget, you may forget, by the time you get to the end, what was at the front. But if you look at the headings and the bottom line, the end result, and you look at the year-to-date before you look at the month, what this does is it may take out timing differences. "Okay, we were under last month. We're over this month." Don't panic. The two even each other out. And if you look at the year-to-date, you'll see that, rather than looking at the month-to-month. Then I go into the detail and look at the individual lines and months.

Identify material positive negative variances. So some people say, "Look, if it's more than 10 percent different to what I thought it was going to be, or if it's more than $5,000 difference to what I thought it was going to be, I'll investigate that further.” So many people give a percentage and a dollar amount. Because sometimes you have a small cost that has varied a small dollar amount, but it's a big percentage. Sometimes you have a large cost that's only varied a small amount, but it's a big percentage. So you need to look at the percentage as well as the dollar amount.

And look at the negative as well as the positive. Because as you're analysing these figures, you want to encourage the positive to continue happening, and try and mitigate the negative from happening. So don't just look at the bad things and try and stop those. Look at the good things and say, "How do I continue this positive?" And part of that might involve drilling down to root cause analysis rather than just looking at the symptom. As you're trying to identify what to continue doing or stop doing, ask yourself why is it happening?

And some might be quite obvious. Some might be more of a root cause. Why, why, why, why, why. And that's what the five why's is about. Ask why five times, to identify the root cause. Because maybe the problem you have is that you didn't plan things up front. Not that you've run out. So you run out is the symptom. The root cause might be a lack of planning at the start of the season. And we identified that as one of the potential wastes. So by asking this “why” five times, you might get back to some of those root cause wastes that we identified previously. And it might not be the obvious symptom that you see.

Second to last dot point, consider how to continue the positive and eliminate the negative, we've spoken about. And review on a regular basis. So I would recommend monthly. Some people might do it quarterly, in line with their BAS because they're getting all the numbers and figures together. I guess my issue with quarterly is that maybe the horse has bolted, and you don't have a chance to fix things up. So have a think about how regularly you'd like to review your actual results to your budget.

And what are some of the corrective actions you can take? And we've identified some of these in terms of some of the cost saving strategies you could use in an earlier slide. But in general, how can I do more, better, same, or less. So we can look at the quantity of things, or we can look at the quality. Maybe we do it different, better, or worse. Maybe we need to maximize our revenue and the timing of sales, et cetera, to get the best price. And definitely we want to minimize our wastes. Some of those root causes we identified earlier, and you have in your homework activity.

How do we improve our cashflow? Might be some decisions you need to make by deferring certain things. At the start of a season, you might structure your borrowings differently. You might review your drawings. You might sell excess assets, or even defer asset purchases as you're going through the year. And we want to have some contingency plans that we might think about. Diversification, which we'll talk about in risk management, webinar five. Rather than buying things, maybe we could hire or lease. Or we could outsource rather than doing things in-house. And definitely new technology might be one of those ways by spending more we can actually save more than it cost us. So a few different ideas in terms of corrective actions you might be able to take as you're going through the season.

So we're coming down to two very broad questions, and summary of what we've spoken about so far. And the key focus of what we've talked about in this webinar is how can you improve variable costs, and your margins that go along with them, through the short term decisions that you make. And these short term decisions that you make are about improving the ratio between inputs and outputs, your productivity, your efficiency. And hopefully you can understand that a little bit better and understand the impact of some of the short term decisions in that 6-1-5 rule of thumb we've talked about. We've been focusing on the one.

So we started by identifying the top three or four variable costs that you have, as a starting point in terms of the main ones you need to focus on. And you might even benchmark those against some others, or indeed against yourself. We then said we'll do some sensitivity analysis, some what-ifs. "What if I change this? What if I did that?" And then we looked at five ways you can be more productive. Sometimes you need to invest money to save money. Sometimes you need to stop doing something, and even if it reduces your revenue, the extra cost of doing it might be more than the revenue it was generating. Sometimes we can't see the forest for the trees. So step back and do those costs of production to see, is it really worthwhile?

We definitely want to reduce waste. And we identified five broad ways of reducing wastes and lots of sub-areas within that, as well as some specifics around livestock and cropping. And lastly, we said prepare a cashflow budget. And put quality assumptions in that cashflow budget to make it the best guess that you can come up with. And then regularly compare that guess, that plan, that estimate, to what is actually happening, to identify some of the issues and take action proactively before the problem becomes too bad and you can't do anything about it. So a bit of a summary of what we've covered so far. A list of references. There's the Bankwest Planfarm, and some really good stuff around cashflow with GRDC there and gross margins. And one from Agriculture WA on generating more profit for your farm business.

So let's just wrap up with our last slide here, in terms of ... We've already done a little bit of a summary, but give people an opportunity to type any questions, especially around the cashflow budget, the second half of the webinar. A reminder that I'll be available between three and five on this coming Sunday, for any one-on-one. So if you want to email me with a preferred time in that slot, and we'll try and coordinate those times. Your homework activity is largely around identifying your top three or four variable costs and how you might do that against an irrelevant benchmark or against absolute dollar amounts, and which one of the variable costs do you need to focus on? And then we say, "Well what specific strategies are you going to use around productivity, those five reductions of waste? And maybe some cropping-specific variable cost reductions and some livestock-specific strategies. And then committing to some actions. And it might be reviewing your cashflow more regularly throughout the year. Or it might be even building a cashflow, or improving the quality of your cashflow. So what actions are you going to take to reduce those variable costs, is the last part of your homework.

Thanks very much guys. I'll wrap up the webinar there, and look forward to talking to you next week with the last of our now series of five around managing risk in your farm. Thanks very much.

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