A Farming Budget
Tyler is $250,000 in debt and is a farmer. How does he budget for something so volatile? Dave explains how to handle the business budget.
QUESTION: Tyler in Kansas is $250,000 in debt and is a farmer. He has 140 acres and farms debt-free, but he’s trying to give every dollar a name and budget and is having difficulty because of varying expenses. How does he budget for something so volatile? Dave explains how to handle the business budget.
ANSWER: To start with, farming is a business. You’re aware of that, and we’re going to set aside your farm as a business question—more like an EntreLeadership question than we would, say, on personal finance around your home.
We’re going to set up a separate business, obviously, and we’re going to run a profit and loss statement on your business, and like any business, we’re going to predict the income as best we can for the year. We’re going to predict our expenses item by item, category by category, as best we can for the year. We’re going to break that out by month as best we can. That’s just called laying out a business pro forma, or a business budget if you will.
Then you’ve got two goals that you want to work on with your profits. By profits, I mean after you have paid your household expenses—paid yourself a living wage, enough to operate—not a bunch of money but enough to operate your house on and feed your kids, keep the lights on, have food on the table, take a vacation, whatever you’re going to do with your household income. So you say that’s your salary, so to speak, out of the business—or your income out of the business.
After you’ve paid that basic living, not big-time profits but just basic living expenses out of the business, then your net profit in the business should be divided among two things right now. It should be divided between retained earnings, which is savings, and debt reduction. The idea being that we’re going to throw the lion’s share of your profits at the debt until it’s gone, but we have to save something for a rainy day. In your case, that could be literal, but the idea being that the emergency fund for the business is called retained earnings.
Retained earnings in business is used for more than just emergencies. It’s also used for buying new equipment in the future. It’s used for buying another 140 acres someday. It’s used for cash purchases to grow the business, but you always have to keep a pad in there in case you have a weird year where your parts budget was off by tenfold. That becomes an emergency because I think you’re saying you either missed your estimate on what it takes to keep parts on your equipment really badly or you just had a really unusually bad year. Then that’s called an emergency, and you would take that out of retained earnings.
You would budget what you really think intelligently—reasonably—parts are going to be as part of your business budget. That’s maintenance and replacement of broken parts and fuel and seed and fertilizer—whatever expenses you have to run the business. They’re all broken out by category, and then if you miss a category really badly—even the income side of the category . . . Let’s say the harvest doesn’t come in as strong as you predicted. Then you’ve still got that retained earnings to catch your slack and keep you from just being \ borrowing money every time you miss an estimate on your budget.
The second thing is this: Having done business budgets for years now, every year that you operate the same business over and over, the better the estimates of your expenses and your income are going to be because they’re based on experience, not just based on a wild guess. The first year you do a business, unless you’re copying somebody else’s budget in a similar category, you’re kind of guessing.
I’m going to keep working on it that way, and if you’re only netting $40,000, that’s probably just enough to take care of your family. You probably don’t have a bunch, but any little bit of stuff you can do to set some savings aside and attack the debt with some out of the business—in other words, if you could live on $35,000 and you put $5,000 toward that formula and said, “Okay, out of that $5,000, I’m going to set aside $2,000 anyway for retained earnings just to get myself in the practice of doing that.”