October 16, 2018
Budgeting and forecasting is an important business exercise. In order to improve any process, like farm management, it’s critical to have a good understanding of the drivers and their impact on overall success. Building a robust projection that allows you to adjust key variables such as production, price relationships and key drivers of cost will provide clarity, making decisions easier and improving your odds of success. A side benefit of a solid projection is that it helps communicate your plans with your lender and internally, with key team members who can help achieve success. In general, business financial planning should give you:
• A greater ability to make continuous improvements and anticipate problems
• Sound financial information on which to base decisions
• Improved clarity and focus of management and leadership
• A greater confidence in your decision-making
Building the budget
Begin with the big variables, starting with pig price. Generally, pig price is some variable from futures markets at a given point. This may be as simple as using futures prices adjusted for seasonal basis. A good historical record of your net price relative to nearby futures over the past few years is a good starting point and defines your basis.
Price discovery methods have become more complex over the past few years, so some adjustments must be made if pigs are being sold under a new arrangement. For example, you may be selling pigs based on the CME Index, Western Corn Belt, or USDA Cutout. Building that basis into your forecast is more complex, but in the end, would still be relative to the lean hog futures.
Generally, forecasts that I see use the same methodology for major feed ingredients. Corn and soybean meal futures are used to determine the forward price when adjusted for local basis. In that way, adjusting the future price moves in commodities will impact the cost of production, returns and capital required to run the business.
The goal is understanding what drives revenue and costs and, — ultimately — return on investment. The model should be robust enough to help build decisions around business management, but it takes investment of time and effort to evaluate budget to actual financial performance over time. Fine-tuning of your farm’s model pays off when production changes, marketing decisions are being made or expansion plans are considered.
Another reason to build a good forecasting tool is communication with your lender. Having a good projection and a handle on the forward-look is critical to making lending decisions and understanding the financial needs of the business. A strong budget includes answers the following questions.
1. Are loans adequate in size to finance the business needs?
2. Are repayment terms realistic?
3. Are loan covenants appropriate for the credit?
4. What are the sensitivities to cost and revenue?
Building a good budget and forecast is just the beginning. The real value is in reviewing performance relative to the budget on a quarterly basis going forward. Make use of a good budget to build confidence in the future success of your business.
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