Having a thorough understanding of your farm business’ cash flow position can reduce stress and put you in a position to make informed decisions about buying and selling grain, lambs, hay, machinery etc.
As mentioned part one, liquidity can affect the long-term viability of a business there are a few simple calculations that can be done to assist in understanding the liquidity or cash flow position of your business.
The ‘current asset ratio’ calculates if and how many times you can cover your current debt with current cash flow. To do the calculation you need to know the total of your current assets (assets that are expected to be converted to cash in the next year, e.g. any debtors, grain on hand, lambs, etc.) and current liabilities (what loans/repayments that will need to be paid in the next year, e.g. creditors, interest and principle on loans, etc.).
By dividing current assets by current liabilities, you get the current asset ratio. You want the ratio to be higher than one, because this means you can cover your current debts, as the number increases it means you have a greater ability to meet those debts. Any number below one means you are unable to meet your current debts.
By subtracting current liabilities from current assets you get a dollar figure representing how much you either have available after paying your debts, or how much extra you need to pay off your debts. A negative number in this instances is not the desired outcome.
To get a better understanding about how a business can service its debts we need to remove some of the assets that are harder to turn into cash. For example, you are going to avoid removing money from an FMD before the end of the year, as this would result in the FMD being ineffective.
In the ‘quick assets ratio’ we only consider cash or cash equivalents and any short-term investments. Once divided by the current liabilities, you can gauge if the business can meet debt in the coming year and thus, how liquid the business is.
Remember liquidity is something that is not easily recognisable from the outside of a business, a business may be profitable, but have limited cash flow. So take the time to do these simple calculations and you will have a better understanding of where your business sits.
For more information about liquidity have a look at:
https://grdc.com.au/resources-and-publications/all-publications/factsheets/2013/11/cash-flow-budget
