Following a presentation on the economic reset, the need for solid 2016 financial management, and the imbalance of commodity prices and operational costs, an online review caught my attention. An individual commented we were getting paid to make it sound like rocket science!
While made in jest, I believe the comment brings up a valuable point: this period of economic reset requires good, old-fashioned basics of financial management – nothing as complicated as rocket science.
The great commodity super cycle, with tremendous profits and asset appreciation, created an environment of complacency. Many producers got away from basic principles that often make a business sustainable. Let’s examine some of these basics that will be critical for your business success in today’s economic environment.
One of the first basics is creating goals, as I describe in detail in a previous KOHL-laborations. In summary, outline your business, family, and personal goals in writing for one, three, and five year terms. This exercise should include any partners, spouses, and stakeholders involved in the business. This simple strategy goes a long way in facilitating communication inside and outside the business with your lender, suppliers, and others.
Secondly, form a team of advisors that may include your lender, crop and livestock consultants, accountant, and a facilitator. You may find an outside perspective included on this team to be useful. Often, working side-by-side with advisors, peers, or mentors can yield a remarkable advantage in navigating difficult economic times.
Next, examine your documentation of profits and positive cash flow. In conducting this analysis, do not rely on tax records. Items such as Schedule F (Profit or Loss from Farming) or Schedule C (Profit or Loss from Business) are not sufficient for use in managing your business. These documents are frequently designed to minimize tax liability by adjusting revenues, cost, and capital investment strategies. Instead, an accrual analysis of the past three to five years is ideal for illustrating true profits. Consider whether your business was profitable during the peak part of the cycle and how profits were dispersed.
In your “back to basics” exercise, update your balance sheet and analyze any changes. Was the net worth gain generated from reduction of principal on debt? Were profits retained? Positive earned net worth is much more valuable from your lender’s perspective than value increases due to simply applied appreciation.
Next, examine your financial trends. Did you build working capital in the positive part of the economic cycle? Lenders like to see a rate of net working capital to revenue or expenses above 33 percent. Below 10 percent, or negative numbers, may trigger a red flag for your lender and hinder your ability to weather the economic reset cycle.
Another basic principle to review is your marketing and risk management plan. Is your working capital protected by contracts and a good marketing and risk management plan? Are your accounts receivable feasibly collectible, and do you have sufficient insurance on your crops and livestock? While these business components may not be glamorous or carry windfall profits, they are the fundamentals of incremental profits that pay the bills, service debt, and meet family living needs.
In today’s economic times, reducing family living costs is an important topic which must be considered. Living cost adjustments are a family affair that require careful budgeting and monitoring. The ability to cut family costs demonstrates shared sacrifice, which was one of the successful strategies used during the 1980s farm crisis.
All assets must be assessed and unproductive assets need to be eliminated. This includes land, equipment, machinery, livestock, and labor (including the human asset). Eliminating some fixed costs will be extremely helpful to both short-and long-term sustainability. Lowering variable costs such as fertilizer and seed, and making tough negotiations on cash rent arrangements are other basics that can add up quickly.
Surviving the economic reset is not about rocket science. However, everyone, including me, can use a reminder to get “back to the basics.” Fundamental financial principles can not only help a business weather the economic reset, but contribute to a sustainable, profitable business over the long run.