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Sustainability – What is It?

Are you sick of buzzwords? They’re everywhere…all the time. Some are actually impactful, but all are meaningless without context.

One buzzword that actually has some meat is “sustainability,” but in the next breath it’s meaningless because it can be over-used, misinterpreted, or put into the wrong context. Often times the word is attached to “environmental” sustainability and conjures up visions of environmental enthusiasts/activists/evangelists, but the term sustainability is simply defined as being able to last or continue for a long time.
Ref. https://www.merriam-webster.com/dictionary/sustainable

Using that frame of reference, let’s focus on the financial aspect.

You have put many changes in place in your business over the years. Ranging from new/improved processes to increased size & scale, each change has had an impact on your business. No question, your intention has always been to implement a change for the betterment of your business. But prior to initiating any action, was an assessment of the sustainability of the proposed change ever done? How did you quantify the impact of the change?

There are many success stories floating around lately about producers who gave up some rented land and increased their overall business profits from doing so. While this is counterintuitive to the deeply embedded mindset that “bigger is better,” clearly the financial sustainability of the status quo was in question for these particular operations.

What is the financial sustainability of increasing the size of the factory (more land), adding capacity (more/bigger/newer equipment), or increasing labor (more people)? Each of these needs to be evaluated beyond the obvious cash costs. What are the incidental costs, meaning:

  • Increasing the size of the factory (More Land) carries
    • Higher ownership/operating costs for PP&E (property, plant, & equipment);
    • More cash to service debt on the asset;
    • Change in insurance costs (which way will premiums go, up or down?)
    • Change in utilities costs (which way will heat and power go, up or down?)
    • More working capital to be able to utilize the increased scale of the business;
    • Etc.
  • Adding Capacity (More/Bigger/Newer Equipment) carries
    • Higher costs for PP&E (property, plant, & equipment);
    • More cash to service debt on the asset;
    • Change in insurance costs (which way will premiums go, up or down?)
    • Change in operating costs (which way will fuel and repairs go, up or down?)
    • Will you need to add staff (another operator)?
    • Will you need to upgrade your systems and/or technology so the new equipment can operate relatively seamlessly in your existing set-up?
  • Increasing Labor (More People) carries
    • Additional cost for benefits (pension, vacation, etc.)
    • Higher management requirement (to approve holidays, implement performance evaluations, conduct scheduling);
    • Any additional tools for employees to use (hand tools, vehicles, computers, etc.)
    • Training costs.

Each of these points above has an impact on the decision to increase the size of the factory, the capacity of the equipment, or the volume of human capital in your business. Evaluating each decision above with a broader perspective, which would include an expected ROI (Return on Investment), is the best way to understand the sustainability of each option. If the desired change to your business provides insufficient ROI, it puts the sustainability of not only the project but your entire business in question. At minimum, ROI must exceed the cost of borrowed capital that was utilized for the project.

Plan for Prosperity

Buzzwords aside, sustainability is as much of a mindset as it is a business practice. Sustainability deserves a place in your business’ values and mission & vision statements. It should make up a component of every business decision that you consider. If your business is not sustainable, what are your plans for afterwards?

Cash Growth and Misplaced Priorities

Cash, Growth, and Misplaced Priority

It’s been said many times by many pundits that “cash is king.” If you are a regular reader of my weekly commentary, you’ll know that I am not one who abides by that line of thinking because Cash Isn’t King. It’s the ACE!

However, GROWTH is King!

Growth is King and Cash is the Ace. What a tandem! It’s no wonder that in Texas Hold ‘Em poker, an Ace-King is known as “Big Slick.”

Recall that growth is not just about size and scale. Growth takes many forms; successful businesses “always grow, and grow all ways.”

The misplaced priority is when business pursues growth (expansion) at all costs, when it puts growth (expansion) above cash. I’ve seen businesses “grow” themselves to the brink of bankruptcy…

In an effort to spread out overhead costs, many businesses are driven to scale up. If rapid expansion is undertaken while in a weak financial position, the business has just been weakened further.

Cash is required to support any expansion plans. Expanding will not fix an insufficient cash position.

To Plan for Prosperity

Expansion plans must be carefully drawn up to ensure sufficient resources are available to support the goal. Expanding with insufficient resources, especially cash, can accelerate the decline of your business.

 

Complex Decision Making

Complex Decision Making

On October 21, 2017, Seth Godin wrote the following:

Decision making, after the fact

Critics are eager to pick apart complex decisions made by others.

Prime Ministers, CEOs, even football coaches are apparently serially incompetent. If they had only listened to folks who knew precisely what they should have done, they would have been far better off.

Of course, these critics have a great deal of trouble making less-complex decisions in their own lives. They carry the wrong credit cards, buy the wrong stocks, invest in the wrong piece of real estate.

Some of them even have trouble deciding what to eat for dinner.

Complex decision making is a skill—it can be learned, and some people are significantly better at it than others. It involves instinct, without a doubt, but also the ability to gather information that seems irrelevant, to ignore information that seems urgent, to patiently consider not just the short term but the long term implications.

The loudest critics have poor track records in every one of these areas.

Mostly, making good decisions involves beginning with a commitment to make a decision. That’s the hard part. Choosing the best possible path is only possible after you’ve established that you’ve got the guts and the commitment to make a decision.

 

With the benefit of hindsight, none of us is ever wrong. We can, without fear of reprisal, predict what just happened 5 minutes ago.

In business, we can not afford to avoid the complex decisions. Leaving it to chance or following the crowd is about as solid of a strategy as allowing “hope” to be your business plan…

In the next breath, we must cut ourselves some slack; large and complex decisions are daunting. It can seem easier to do nothing than to tackle a complex decision and risk making the wrong choice. But, as Godin wrote, “making good decisions involves beginning with a commitment to make a decision. That’s the hard part.”

To Plan for Prosperity

“Paralysis by analysis” is an old adage that accurately and humorously describes our inability to make a decision (and act on it) because we never stop considering different options. We might feel like a failure, or inept, if we don’t get the decision right.

In reality, more opportunities are lost from perfect inaction than there are mistakes made from imperfect action.

Halloween

Happy Halloween

Let me first get this off my chest.

In this age of hyper-political-correctness, to hear of some schools that are “cancelling” Halloween because of the risk that some costumes might “offend” or “scare” someone is taking us down a path that we may not be able to come back from. I’m not a proponent of Halloween, but I’ll gladly encourage anyone who wants to take part in it to do so, and anyone who doesn’t can also do so. What we need to remember is why we do it, even if we don’t love it…IT’S FOR THE KIDS!
It’s THEIR imagination and THEIR excitement that must not be squelched just to satisfy our guilt over ________ (fill in the blank).

Thank you; now onto the real business at hand.

Getting dressed up in a costume creates an outlet for us to be something we’re not, or maybe something we wish we could be. (As a kid, I wanted to be a pro-football player and might have dressed up as such for Halloween.)

Over the last several years in western Canadian agriculture, “average management” has been dressed up in a costume of “excellence.” With high yields and high commodity prices, even average managers were more profitable than they had been in the long term…maybe ever.

Dr. David Kohl uses the term “black swan” to describe the recent commodity super-cycle because, like a black swan, it is “not the norm.”

black swan is an event or occurrence that deviates beyond what is normally expected of a situation and is extremely difficult to predict;

Source: www.investopedia.com

While we might be inclined to associate black swan occurrences with negative deviations from normal, in the case of the last 10 years in agriculture, we’ve experienced a positive deviation from normal. The danger came when many participants in the industry believed that what was happening wasn’t actually a black swan but “the new normal.” Many long term decisions were made based on short term results. True to the black swan definition, the onset of the commodity super-cycle was predicted by very few, and even fewer still predicted it would last as long as it did. Maybe it was the fact that it did last longer than a year or two is why people started to believe it would never end…?

The unpredictability of this black swan continues to cause angst among players in the industry. Some are soldiering forward as they have for the last several years with full expectation that the black swan will return. Others are are in full damage control mode, or even panic mode. Others yet are patiently waiting for the opportunity that always follows the economic cycles.

Market cycles will hurt some, but offer opportunity to others.
The difference between who suffers and who prospers is…Who’s Ready.

– Kim Gerencser

I started making that statement way back in late 2012. The message then was to take advantage of the current up-cycle to solidify your business in preparation for the upcoming down-cycle (because bulls are always followed by bears, which are followed by bulls…it is how cycles work.) Being greedy during an up-cycle brings up another old adage, “Pigs get slaughtered.”

To Plan for Prosperity

When preparing your 2018 projections, compare your projected expenses to your worst revenue in the last 10 years. Is there a negative gap? How big is it? What needs to be done to cover it? Alternatively, is there a positive gap? How big is it? What needs to be done to protect it, or even to leverage it so as to make it wider?

The exercise proposed above is comparable to removing a Halloween costume. While things look one way outwardly, what is actually happening underneath, at the surface, can sometimes be much different and will tell the true story.

Happy Halloween!

PS. Don’t wear your Halloween costume to your banker meeting.

Soil Testing Home Farm

Soil Testing Season

This is the time of year when soil probes all over the prairie are taking samples of the soil that provided the crop in the current year and will provide another crop next year. It’s an annual “check-in” to see what’s left.

It was the same about a year ago. We check what nutrient levels remain after harvest, consider what crop will perform best in each field next year, and begin to apply appropriate nutrients (following the 4R’s of Fertility: Right Source, Right, Rate, Right Time, and Right Place) in fall and/or in spring. The crop get’s sown, produce get’s harvested, and we check the soil again. Based on what we started with, what we added, and what the crop used to through the growing season, we compare to what is left in the soil to evaluate how efficient our fertility program was.

If it wasn’t as efficient as it could have been, we examine the effects on our production (moisture, heat, disease, insects, etc.) and we examine our own role in the process by questioning if the seed tool did a good enough job; how about the sprayer? Often time we use weather as the justification to acquire bigger, newer equipment to “get the job done faster.”

What if the entire industry, not just the progressive managers but the entire industry, used that same methodology in analyzing profit and cash flow? It might look something like this:

This is the time of year when spreadsheets all over the prairie are being used to tally up the performance of the business over the last growing season. We start with the working capital we had after last harvest, consider what crop will perform best based on your crop rotation and market outlook, and begin to project input costs and yield & price for each crop. We enter expected operating and overhead costs into a projection, and convert those projections to “actuals” as the year progresses. Once harvest is complete, we evaluate working capital again.

If profitability and cash flow was insufficient to meet expectations, we examine if operating costs stayed within budget or not (and why), we examine if overhead costs were projected correctly or if we let both operating and overhead “get away” this year. What did we not foresee? What did we properly plan for? Did we market appropriately?

The practice of soil testing compliments crop and fertility planning. These are crucial steps to take to create the most efficient plan. Remember, you need to produce at the lowest cost per unit possible. Period. Hard Stop.

The practice of checking financial performance is similar to keeping score. It would be awfully tough to know what adjustments need to be made during the game (growing season) without knowing the score along the way.

To Plan for Prosperity

It’s been said by agronomists that soil testing is “seeing what’s in the bank account” and they carry on in supporting that analogy by stating that no one would write a cheque without knowing what the bank balance is first. Sadly, there any many people who do both: write cheques without knowing what’s in the bank and plant crops without knowing what’s in soil. One won’t break you, the other could.

Knowledge is power. Knowledge comes from management. Management requires measurement. Test your soil (financial performance), because if you don’t measure it, you can’t manage it.

 

**Side note: the photo is from my farming days, and provides a glimpse into the soil I used to farm. I found it interesting to so clearly see the A, B, and C horizons in a single core. **

Know the Signs

Know the Signs

When you see a cow that is limping, you check her out to see what the ailment is. A prudent cowperson can quickly recognize foot-rot and will tend to the cow to make her well again.

When you see yellowing bottom leaves and/or thin, spindly plants in the canola crop, you know it is lacking nitrogen. If you see the signs in time, you can top dress nitrogen fertilizer onto your crop and see a positive benefit.

When we see a tire is low, we fill it.
When we see windows are dirty, we clean them.
When we find the level of fuel in storage is low, we order more fuel.
When cash flow is abundant, we spend it in ways we wouldn’t usually spend it.
Yet, when working capital is depleted, when cash flow is tight, or when profitability is dicey, we typically soldier on…doing what we’ve always done.

This makes no sense. The last two sentences above make no sense at all.

When the bank account is empty and the line of credit is nearly full, do you:
a) Apply for more credit, at your primary lender or elsewhere?
b) Evaluate your cash outflow to date and reexamine your plans for the rest of the year?

When working capital as slipped down so low it would barely cover the crop inputs loan, do you:
a) Analyze what caused the current situation?
b) Seek action to rectify your working capital position?
c) Both a) and b) ?

The case for “knowing the signs” is made by acknowledging the impact of each risk that is identified.

In the crop, the yellowing of canola leaves won’t spur any action if the risk to yield potential is not understood.  If the risk is understood, then an informed decision can be made to act or not act. If there is no effort put in to understanding the risk, then the decision to act or not act falls somewhere between apathy and laziness. Being ignorant to the specifics of the risk and its implications is no longer an excuse now that we have access to all of humankind’s knowledge in our pocket…

If you’re unaware of what are the signs of nitrogen deficiency in canola, if you’re unaware of what are the risks of foot-rot in your cattle herd, you are best to seek advice from an expert.

To Plan for Prosperity

The risks of maintaining insufficient working capital, and the risks from shortfalls in cash flow, are obvious to those of us who specialize in the financial side of business. We know the signs. We know what it takes to fix it. We know what should happen to ensure the situation isn’t repeated.

 

top producer

Are You a Top Producer?

Esteemed economist, Dr. David Kohl, is a fervent advocate of improving business decision making. In one of his recent speaking engagements, Dr. Kohl suggested that top producers can answer Yes to at least six of the following questions.

Top Producer Kohls questions

With only 10 questions on the slate, a positive response to only 6 of them would make you a top producer.
You’ll note that nowhere in those 10 questions will you find anything about actual production…

To Plan for Prosperity

If you are unable to answer YES to at least 6 of Dr. Kohl’s questions, then I suggest you do an internal audit on yourself and your business to determine why. If you are unsure about where to start in doing such an audit, or how to make the changes necessary to be able to answer Yes to 6 of 10 questions, then pick up the phone – I can help.

If six-out-of-ten makes you a top producer, imagine how strong your business would be if you hit 10/10…

Return on Assets

ROA (Return on Assets)

Return on assets, or “ROA” as we’ll refer to it, is an often overlooked financial metric on the farm. Partly, I think it is because there is a culture in agriculture that places too much emphasis, even “romanticizes” the accumulation of assets (namely land, but mostly equipment.) This doesn’t necessarily bode well for ROA calculations. But the greater reason ROA isn’t a regular discussion on the farm, in my experience, is because it is not understood.

return on assets formula

The math is simple to understand, so when I say “ROA is not understood,” I mean that the significance of ROA, and its impact, is not appreciated.

Return on Assets is a profitability measure. Its key drivers are operating profit margin and the “asset turnover ratio.” ROA should be greater than the cost of borrowed capital.

Let’s ask the question: “When calculating ROA, do we use market value or cost basis of assets in the denominator?” The simple answer is “BOTH!”
Do two calculations:
1) using “cost” to measure actual operational performance;
2) using market value to measure “opportunity analysis” which is a nice way of saying “could you invest in other assets that might generate a better return than your farm assets?”

Operating profit margin is calculated as net farm income divided gross farm revenue, and is a key driver of Return on Assets.

The asset turnover ratio (also a key driver of ROA) measures how efficiently a business’ assets are being used to generate revenue. It is calculated as total revenue divided by total assets. The crux of this measurement is that it has a way of showing the downside of asset accumulation. The results of this calculation illustrate how many dollars in revenue your business generates for every dollar invested in assets. While there is no clear benchmark for this metric, I’ve heard farm advisors with over 3 decades experience share figures that range from 0.25 to 0.50. This means that for every dollar of investment in assets, the business generates 25-50 cents of revenue (NOTE, that is REVENUE not PROFIT).

If assets increase and revenue does not, the asset turnover figure trends negatively.
If revenue increases and profit does not, the operating profit margin trends negatively.
Increasing revenue alone will not positively affect ROA. “Getting bigger” or “producing more” alone without increasing profit does not make a difference. If you recall: “Better is better before bigger is better…”

To Plan for Prosperity

As you will find in many of these regular commentaries, the financial measurements described within are each but one of many practical tools to be used in the analysis of your business. Return on Assets cannot be used on its own to determine the strength or weakness of your operation. But used in combination with other key metrics, we can determine where the hot issues are, and how to fix them so that your business can maximize efficiency, cash flow, and profitability.

Per Acre Equipment Investment

Per Acre Equipment Calculation

In the June 8, 2017 edition of the Western Producer, columnist Kevin Hursh penned Per acre equipment calculation can be revealing. As is typical, Hursh hits the nail on the head with this piece by suggesting farms should know their equipment investment per acre. His column goes on to describe how new equipment has seen significant increases in SRP (suggester retail price) over the last few years, contributing greatly to the elevating of the “per acre equipment calculation.”

First, let’s figure out where you are at. Add up the current value of all your equipment, owned and leased. If that total is $2.5million, and if your farm is 5,000 acres, your equipment investment per acre is $500. If we compare that to a 2,500 acre farm with $1million invested in equipment (therefore $400/ac), who is better off?

Measure it against earnings

Last year, I had a client tell me about a meeting with his lender. This particular client is small acreage, relatively speaking (under 1,000ac in crop) and yet was quite well equipped for his acres. He carried minimal debt, and despite some cash flow challenges over the previous two years, his working capital was still very strong. He was seeking a high-clearance sprayer so that he could ensure timely fungicide applications for his lentils, and other high value crops. The feedback he received from his lender was that his “equipment investment per acre was to high.” On the basis of that single calculation, it most certainly was. What the lender failed to evaluate was the entire farm profitability. Because of the small acre base, my client was able to produce a rotation of high-management high value crops. His net profit per acre was almost double a typical grain farm. His ability to justify a high equipment investment per acre was evident. Needless to say, he acquired his sprayer (a used model valued at just north of $100,000) pushing is equipment investment per acre from $484 to $644.

Let’s go back to the 2 fictional examples above.
EBITDA vs Per Acre Eq InvIf we only looked at equipment investment per acre, we would likely conclude that Farm B is in a better situation by only having $400/ac invested in equipment versus Farm A having $500/ac. Yet when we dig further by bringing EBITDA into the calculation (EBITDA is Earnings Before Interest Taxes Depreciation & Amortization) we discover that Farm A generates stronger EBITDA per acre than Farm B, and is therefore possibly justified in having a higher investment per acre in equipment. In practical applications, even this doesn’t go far enough to determine which is better, but it’s a start.

To Plan for Prosperity

Delving into management calculations can be daunting and confusing. If we don’t know what to look for, how it compares, or even if we’re not measuring anything, we’re already behind before getting started. Begin by measuring the many facets of your business; in this case, “What is your equipment investment per acre?” How has is changed over the last five to ten years?

Relating back to my client, his EBITDA was a whisker under $120/ac, so his EBITDA to Equipment Investment on a per acre basis was about 0.186:1. This means that with his equipment investment of $644/ac will generate about $0.186/ac in EBITDA. Is that a good metric? As Kevin Hursh closed his column, “It’s unfortunate that more information isn’t available on the typical investment levels in each region. That would allow producers to make more relevant comparisons.”

Canola 100 fail title

Why the Canola 100 Challenge is So Wrong

Announced two years ago around this time, the Canola 100 challenge baits farmers into taking part in a “moonshot”: an attempt to produce a verified canola yield of 100 bushels per acre. It isn’t that efforts to increase yield aren’t a good thing, because they are. But by what means are we attempting to achieve these yields?

This “contest” may be virtuous in spirit, but it overlooks the not-so-old adage that “better is better before bigger is better.” That applies to this argument too.

The rationale behind my position is supported in this Western Producer article that describes a farmer’s chase of this moonshot, throwing everything including the kitchen sink at his crop in an attempt to cash in on the Canola 100 prize. (Spoiler alert: it failed miserably.) This particular attempt can be summarized in this quote from the article:

The fertility program cost $300 per acre more than what was done to the check field but yielded only 70 bu. per acre, which was 1.4 bu. per acre more than the check field.

The driving factor behind efforts to maximize yields should be ROI (Return on Investment) and Gross Margin. Doing so would focus on maximum economic yield, not maximum production yield. There’s something about that pesky law of diminishing returns that gets overlooked when trying to shoot for the moon…

If maximum economic yield is the target, then Gross Margin is the focus. How that gross margin is achieved is up to each producer, but make no mistake about where the focus needs to be. In my experience, minimum gross margin, that is gross revenue less seed, chemicals, and fertilizers, at MINIMUM needs to be 65% to sustain the business. High cost operations need greater gross margin to cover all those costs.

To put that in reverse, if 35% of your gross revenue can go to crop inputs, then each $1.00 invested into inputs should return $2.86 in gross revenue. To apply this to the example above, the “extra $300 per acre” in fertility should have delivered $858/ac in gross revenue. If Canola was $10/bu, that’s nearly 86 bushels per acre above the check field.

Canola 100 fail

Let’s push the argument harder: if the example above actually hit 100 bushels per acre, and acknowledging the control field yielded 68.6 bu/ac, the gross margin on the Canola 100 plot was $14 per acre, or about 4.67%.

This is IF the 100 bushel yield was achieved…and face it, $14 gross margin doesn’t pay many bills; in fact, it wouldn’t even buy the fuel for the contest plot.

To Plan for Prosperity

Make no mistake about the messaging here: as a producer of commodities, you need the bushels!!! But do not lose sight of the fact that as a producer of commodities, your only chance of remaining sustainably profitable is to produce at the lowest cost per unit. Period. Chasing maximum yield at a 1:1 ROI won’t get it done.

1. What is your historical gross margin?
2. What are your operating and overhead costs?
3. Know these to be able to plan for maximum economic yield.