balance sheet

Balanced View of the Balance Sheet

Like any piece of business information, the balance sheet is only as useful as the quality and accuracy of the information presented in it. In my experience, the balance sheet either gets too much emphasis or not enough. Too much when a business is not profitable, but always falls back on “Well we (they) have strong equity.” Too little when a young business is in high growth phase and is focused on nothing more than the next expansion opportunity, usually at all costs.

The construction of a balance sheet is quite simple: assets on the left, liabilities plus owner’s equity on the right. As the name implies, the two sides must balance. So when liabilities are greater than the assets, there is negative equity. Yes, you can have negative equity, but not for long unless you have an incredibly patient banker.

When describing the instances above where the balance sheet gets too much emphasis, the focus is clearly on the bottom half of the balance sheet, specifically the long term assets & long term liabilities and the owner’s equity. The equity is usually provided by appreciation of long term business assets, and if the equity is built almost solely on that and not retained earnings (net profit from operations) then there is definitely too much emphasis put on the bottom half of the balance sheet, namely equity.

The top half of the balance sheet is where most of the trouble starts. The top half is where we find the current assets and current liabilities; the difference between the two is working capital. Current liabilities have grown to dangerous levels from ever increasing loan and lease payments, cash advances, and trade credit. When current liabilities exceed current assets, you have negative working capital.

If your balance sheet has negative equity and negative working capital, you are the definition of insolvent, and the next phone you make is likely 1-800-AUCTION.

Ok, so there is equity on your balance sheet, more than enough to cover off the negative working capital. A patient and understanding lender might be willing to help you tap into that equity to “recapitalize” the business.  Do that once if you need to. By the time you’ve gone to that well two or three times, you’re likely closer to needing the classifieds to find a job rather than the next deal on equipment.

Equity doesn’t pay bills. Cash does.

Why punish your cash and working capital by rushing debt repayment to create equity?

Plan for Prosperity

The next time you catch yourself, or anyone else for that matter, leaning hard on the bottom of the balance sheet, namely the equity portion, think long and hard about why the focus is not balanced between the top half and bottom half of the balance sheet.

Not only do the left and right sides of the balance sheet need to balance, but so does the top and bottom.

Rayglen 2018_2019 proj crop returns

The Great Profitability Challenge of 2018

The graphic seen above was shared at a recent CAFA chapter meeting (Canadian Association of Farm Advisors) and forwarded to me by one of my fellow CAFA colleagues who was in attendance. By coming from a reputable commodity trading entity, there is a level of trust we can have in the data presented.

And the (projected) data looks bleak.

With only four crops expecting a net profit to exceed $50 per acre by any respectable amount, the profitable options for 2018 are few and far between. No wonder the common sentiment this winter is “I don’t know what to grow this year; doesn’t look like anything will make a profit.”

Considering the four crops in the Rayglen projection that are close to abundantly profitable are 1 variety of chickpeas and 3 varieties of mustard, it’s pretty clear that your geography becomes part of your challenge. Yes, wheat, barley, flax and canola are also projected to be positive, but are any of them sufficient based on the risk and/or your personal circumstances on your farm?

Here are some questions that I feel must be asked:

  1. Is crop rotation holding you back from loading up on what few profitable options are available?
    I recently heard a lender suggest that those who blow up their crop plan to chase the perceived winner, by his account, usually miss out.
    This can be often true because of the long cash conversion cycle in production agriculture. Farmers bet on a crop plan that they expect will make them money, but a lot can happen between February and harvest…the market giveth and the market taketh away! If there is one thing Western Canadian grain farmers can do, it’s produce! We can overproduce a commodity in as little as one crop cycle, and as such in July or August drive down what was a winning price back in February!
    The lender referenced above went on to say that sticking to your proven crop plan is the way to hit a winner most years, maybe even multiple winners!
  2. Is $50 per acre or even $75 per acre net profit realistic, or even sufficient?
    How much was expected yield and/or price “padded” in that projection? How much were total costs “softened”? Were there 4-6 applications of fungicide built in to those chickpea projections?
    Generalist type of prognostications like this one need to be taken with more than just a grain of salt. Do the “variable” and “total” expenses displayed reflect your farm? What is included in each category? Are they including all expenses, including the PAPERCLIPS? There is much ambiguity in figures like these.
  3. Do whole farm expenses reflect the capability of the crop plan, or is the crop plan now expected to meet the ever-increasing farm expenses?
    Recently, I’ve overheard a couple of pundits suggest that whole farm expenses are now nearing $400 per acre. If true, that relegates many crop plans into the underworld of “operating loss.” I’ve gone on record several times suggesting that the elongated commodity boom recently ended has allowed many bad habits to form at the farmgate. The habits in question surround the insatiable appetite for newer/bigger farm equipment, larger land base, and higher living standards. It wasn’t long ago that top tier farmers kept their operating costs (described by some as labor, power, & equipment) in the range of $90-$100/ac, and these pundits now suggest that the best of the best are in the $140-$150/ac range. That $50/ac increase in what is the most controllable facet of farm expenses clearly has shaken the profitability potential to its core on many farms. And that only applies to those whose operating costs have increased by ONLY $50…

Plan for Prosperity

The recipe for profitability is simple:

  • Have a plan (how/why/what you do);
  • Run lean;
  • Know your numbers & market to your numbers;
  • Maintain discipline.

Of course, if it was as simple to do as it is to describe, everyone would simply do it. Also, did you notice that nowhere was there anything in that recipe about production or farm size? In the commodity business, the winner is the one who produces at the lowest cost per unit of production; the best way to achieve that is to have a plan and maintain discipline to it, get lean and stay that way, and finally market your production to your numbers (not to your emotion.) If you’re have challenges with any of the four ingredients in that recipe, why haven’t you picked up the phone and called for help already?

 

Financial data

Questions from Farmers

Over the winter, I do a number of speaking engagements, usually around finance and management. Here are some questions and comments from the audience, and excerpts of my response.

 

Farmer: How do I improve my working capital and current ratio?

Kim: Simply put, either reduce your current liabilities or increase your current assets…or both! Considering current liabilities, what makes up the lion’s share? Typically it’s lines of credit, cash advances, and loan payments due in the current year. So to achieve the goal of reducing current liabilities, over time (because it will take time) wean yourself off of operating credit. Protect, even hoard, your cash over time so that you can achieve working capital equal to 50% of your annual cash costs. By the time you achieve that level of working capital, your current ratio should be very strong.

 

Farmer: As someone who is still in growth phase, I can’t expect the kind of return on my cash costs that you’re suggesting. Isn’t it okay to run at zero because I’m in a growth phase?

Kim: First, your business and the industry are cyclical, so yes there will be years when your return is zero, but don’t accept being at zero year over year for any length of time. That being said, your growth phase is likely running your cash to zero, and what I’m prescribing as “return on cash costs” is a profitability measure; they’re different. A business can be profitable and have no cash because the cash might be immediately fed directly into the growth of the business. Yes, you’re going to run tight on cash during a growth phase, but don’t accept poor profitability.

 

The following are a sample of comments made by participants:

  • Mentioning “Mission” and “Vision” statements is interesting. I don’t think having one makes you more money, but it’s funny how those that have one are doing better than those that don’t.
  • I’m trying to figure out how to value unborn calves when looking at my working capital.
  • This current ratio figure is going to swing widely depending on when (what time of year) you do it.
  • Don’t buy (something like equipment or pick-up trucks) just because you have some cash.
  • We’ve got someone doing our books for us, and we review all our ratios monthly.
  • I never viewed HR as a risk before.
  • Every farmer should attend this seminar. Even if they know everything you’ve discussed, it’s a good refresher.

 

Plan for Prosperity

There is a reason I use the heading “Plan for Prosperity” for my closing comments: we need to plan our businesses. Whether that be our 10 year strategy, the next 18 months of cash flow, or determining how our growth aspirations would be affected by a rising dollar or rising interest rates, planning is key to your business. And the planning must, yes…MUST, go beyond the crop plan. That crop plan is but one aspect of your business. Don’t ignore the others unless you don’t want prosperity.

When considering how to approach the plans you must address in your business, consider the following three questions in order:

  1. Why do we do what we do?
  2. What do we want to achieve?
  3. How will we do it?

If you’ve managed to provide honest and detailed answers, the rest of the “planning” becomes much more clear.

 

roi

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.

 

Goal Congruence_LI

Goal Congruence

Have you been beat up enough yet about “defining your goals”? Every article I read relating to business management and every presentation I attend relating to business management always brings up the need for you as the businessperson to “define your goals.” For the record, “business management” in the context of this piece also include business transition (succession) planning.

The beatings will continue. They’ll continue as until everyone doesn’t just listen to the advice, but acts on it.

More often than not, when I ask a client (or even a prospective client) what are their goals, I get a blank stare, as if the concept is a foreign language. Far too many business owners have given little consideration to what they are trying to achieve in the business.

If it’s just a place to work and/or a lifestyle to enjoy, then declare it as your goal.
If it’s a family legacy that has been left to you that you intend to leave to your children, then declare it as your goal.
If it’s to achieve the largest scale in your market area, then declare it as your goal.
If it’s to create financial wealth and prosperity for you and your family, then declare it as your goal.

Don’t just tell the advisor you’ve hired, and paid well, that your goal is “to make more money.” That’s everyone’s goal, whether employed for someone else or self-employed like you. Let’s get serious.

There are four sample goals described above. These four have been chosen because they are the most common goals I have identified in working with entrepreneurs for the last 15 years. What I mean by “identified” is that while some of these goals have been declared, it’s more common that the goal is insinuated by (or surmised from) the behavior of the owners. The problem is when business owners try to combine more than one of those four sample goals listed above; this happens almost all the time.

The first goal listed, lifestyle, is not congruent with any of the other three.
We’ve learned that largest scale does not automatically equate to increased financial wealth and prosperity; again, not necessarily congruent.
The only congruity among the four samples is between family legacy and financial prosperity.
– yet behaviors often do not follow those goals.

It is advisable to have multiple goals in business and in life. In business, none of the goals we may have can be achieved without prudence in financial management. Remember, profit feeds your business, it feeds your family, and it feeds your ability to spend time with your family & on other things you enjoy. If you feel uncomfortable declaring one of your business goals to be financial wealth because you don’t want to be thought of as a greedy person, then don’t declare it, but for the sake of your business’ and your family’s future, behave like it. If you’re not profitable, if you’re suffering under the pressure of non-existent working capital, or worse, then none of your goals are achievable. Period. Hard stop. I’m sorry to have to deliver that cold truth in such a harsh manner.

To Plan for Prosperity

The challenge I lay out for all entrepreneurs is this: be clear on why you do what you do, establish working parameters and behaviors that support it, and evaluate your progress & results regularly to ensure you’re still on track. How sad would it be to never check the map for the entire journey only to end up somewhere you never meant to be?

Not only must your goals be congruent, but your behaviors must be as well. You and your business face enough turmoil, challenges, and risks. Don’t create more challenges by making decisions that aren’t congruent with your goals.

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.

profit

Is Profit a Part of Your Strategy?

Recently I met a confident cattleman who clearly displayed zero interest in what I do for clients and how they can benefit. He was very direct in describing his costs, and knew his break-even on his animals (right to the paperclips.)  He received a compliment from me on being ahead of many of his competitors.

To test me (or so I think this is why) he asked what he should do with his heifers this fall. After admitting that I am not an astute cattle market advisor since most of my work with farms are grain farms, I asked what his thoughts were if he and I weren’t having this conversation. He said he’d keep them and only cull a handful of cows. Doing so would increase his breeding herd by one-third. This, at a time when we’re coming off a serious drought which has left feed stocks and pastures in tight supply and at premium prices.

He sold fed calves this fall for enough to make a tidy profit. In the same breath he bemoans the price insurance premium he paid this year. I wouldn’t have thought that creating enough profit from operations so as not to need risk management programs was a bad thing…

Further to his question about what to do with his heifers, I said that I’d first need to know where the market is headed by taking a look at the futures market for beef and for the Canadian dollar. This was a lead-in to ask him if he does any hedging. His response was, “No, we’re not on the right side to do that.” Puzzled, I asked him to explain. He described how “lots of guys out there hedge the dollar, price all their barley, and contract their sales…basically they’re doing everything to lock in a profit.”

I let that statement stew for a moment; I wanted his own words to sink in.

Then I just blurted out, “That sounds fantastic! Why wouldn’t everyone do that?”

There was no response.

It was at that moment that I knew there was no point berating the issue further. Here was a cattle operator who knew his costs but refused to use that knowledge to his betterment. There was nothing I could say in that moment that would lead him to take a different action.

To Plan for Prosperity

Profit is not a bad thing, it is a very good thing and business must do everything possible to maximize it. The story above is real, and more of the story includes a decision on whether this cattleman should pursue off-farm employment because the cattle alone aren’t providing sufficient income.

I’m puzzled at how off-farm employment along with the cattle herd simply creates more work and is an option being considered, yet more work to maximize profitability in the cattle herd (hedging strategy) isn’t work that is desirable.

Profit feeds your business, it feeds your family, and it feeds your ability to spend time with your family & on other things you enjoy.

Profit is not a bad thing, it is a very good thing.

Is profit a part of your strategy?

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. **

What Do You Care About

What Do You Care About?

What do you care about?

In a conversation with a fellow business advisor recently, the topic was about how much demand for our services there would be this fall considering the drought, rising interest rates, a rising Canadian dollar, and volatile crop prices. He said to me, “The work we do is important; people need our help,” and then went on to say how he expects there to be significant demand from the marketplace for our financial advisory work.

I questioned whether the farming industry is “generally” ready to place enough importance on financial matters of cash flow, profitability, and leverage to create the demand he described. My experience is that there are pockets of business people who see the value and hire the help, but generally the financial woes faced at the farmgate have yet to cause enough pain to spur on action.

Change will only occur when the pain of change is less than the pain of staying the same.

It seems like there is always something more important.

His response, “People will tell you what is important, and very clearly too! It’s their behavior. Their actions show you very clearly what they care about most.”

Based on how farm equipment sales continue to be incredibly strong, despite challenges to cash flow and profitability, it’s not rocket-surgery to figure out what is a top priority among farmers…

Faced with a choice of one response over the other, how would you choose:
What do you care about?
a)
Ensuring a profitable enterprise for long term growth and sustainability
b) Having a modern/late model fleet of machinery

a) Investing in the crop that provides your income
b) Investing in an “asset” that is a merely a cost and reduces your profitability 5 different ways

a) Getting bigger
b) Getting better

Years ago (WAY back) when I drove a fuel truck for a living, one of my customers always needed significantly less heater fuel (fuel oil) than any other customer on the regular monthly top-ups during one particularly cold winter. It’s not that his house was that new or air-tight; it was not that he didn’t have the money to pay for the fuel (they were a wealthy family.) It was that, by his own admission, he “kept it as cool as possible in the house, about 64 (degrees Fahrenheit).” This was a family of 6, with kids ranging in age from 10-18, whose comfort was less important than money. By his behavior, it was clear what he cared about most.

To Plan for Prosperity

If you feel like you might be facing a choice this year as you evaluate your financial performance, you won’t be alone. Hard choices need to be made by business-people everywhere, every year, all the time. When considering what choice to make, first ask yourself “What do you care about”. When what you care about is clear, the strategy and the action become obvious.

If you are having difficulty defining what you care about, look at past behavior: it will paint the picture for you.