It’s no secret that I have a day job as an accountant. It started as a means to an end and has turned into so much more. It was one element of a fairly detailed business plan. Business plans change though, they are not set in stone and should be updated frequently. And that job that takes you away from the farm can be turned into an income diversification tool that boosts cash flow.
It took me ages to come to terms with using off-farm income as a longer-term strategy. Most of today’s media presents off-farm work as a necessary evil for farm families due to low margins. It’s so common to have an off-farm job that the agriculture industry has jokes about it. I consider it a good business strategy.
Hard Math
My job brings home about $45,000 after taxes. This is what we live on, and what we would need in actual income for me to stay home on the farm. Assuming I stay at the same combined federal and provincial tax rate of approximately 15%, this translates to needing at least $53,000 of pre-tax profit ($45,000 divided by 1 less the tax rate).
Our margin per lamb sold is approximately $36. This means with our current production costs, we would need to sell roughly 1,472 lambs annually to replace the day job ($53,000 divided by $36). Realistically we can expect to market 1.6 lambs per ewe so to sell 1,472 lambs we would need at least 920 ewes.
That math is oversimplified and ignores the costs of scaling up. Expanding the ewe flock comes with its own costs, it would take more land, more infrastructure capacity and more labour. It also does not take into account non-deductible cash flow expenditures like principal repayments on loans and capital asset purchases. This is where cash flow statements are really useful.
Cash is King
Cash is vital, reporting a loss for several years is less of a problem than a negative cash flow. Most accounting software will generate a cash flow statement for your farm. Combining the income statement and cash flow statement gives a much more detailed picture. For us, that picture is not pretty, it’s even bleaker if we want to rely solely on lamb production for income. There’s numerous analysis I can do with a cash flow statement that is hidden from the income statement.
I can determine the farm’s levered free cash flow and express it as a percentage of operating cash inflows. Here that number has averaged 9% for the last few years. This can be flipped into a ratio (1:0.91) showing for every dollar the farm brings in, $0.91 of that flows back out. Essentially, we are cash flow positive but not by a whole lot (see Farming without Credit for more on this part of our story).
Our biggest source of free cash flow is my day job because it comes with very few direct expenses. If I wanted to get the same kind of levered free cash flow out of the farm, our inflows would have to increase to $500,000 ($45,000 divided by 9%). That’s a lot of lambs, close to double the amount calculated above (assuming $175/lamb that’s 2,857 lambs).
Resource Limitations
Besides the cash flow problem, there are also other limits. A day only has 24 hours, one person can only do so much work and land has maximum yields. Respecting the limits of the available resources is vital. Burnout and exhaustion are signs of human limits, hard work and long hours will only get you so far. Acquiring more resources generally has a cost of some sort whether that is time or money.
Once upon a time, we had the goal of filling the barn and running enough ewes to function without off-farm income. Our farm happens to be Class 3/4 sandy loam with poor drainage. Our land cannot produce enough feed to support more than a couple of hundred sheep consistently. Maybe one day but it’s not possible to reverse decades of mismanagement in a few short years. Recognizing this limit has changed our business plan and operation.
Where Limits and Options Collide
The calculations above illustrate that under current circumstances, relying solely on sheep for income would be a mistake. It’s like that old proverb, “never put all your eggs in one basket.” Counting on only one source of revenue is a recipe for a lot of sleepless nights at some point. Using different streams spreads risk and increases overall income potential. While specialization has its perks, I believe diversification is a safer strategy.
Adapting our business plan took a lot of drafts. The sheep are profitable, they’re just not profitable enough. Each lamb is only worth so much so it takes a lot of lambs to grow the cash flow. There are of course other agriculture sectors with potentially higher margins. We don’t have the land or capital to add another significant segment to the farm.
So instead we’ve altered plans to remain at 300-350 ewes and worked hard to set up our operation to be the hours-equivalent of one full-time job. We moved away from a strictly accelerated lambing schedule to a more flexible approach. We opted to let our current land base constrain the number of ewes we run to keep our feed costs under control.
This means keeping my day job is the best option for us as it brings in another source of revenue without increasing expenses, therefore boosting net cash flow. It’s a lot less complicated to increase that job’s free cash flow by $1,000 than it is to increase the farm’s. That day job has allowed my husband and I to accomplish a number of goals that would not be possible with sheep alone.
Caveat
These numbers are real and our current reality. These numbers fall in line with the latest CECPA information where the benchmarked farms are selling 1.57 lambs per ewe, however, they have a negative margin of $57 per lamb sold (operating at a loss). You can access the latest CECPA information for lambs here. Most farms and businesses have more than one source of revenue. If you want the exact formula for levered free cash flow, please read this.
That’s all for today, thank you for reading! If the cash flow analysis was intriguing for you, reach out and let me know.