Kohl's notes
In your experience working with producers, is there
one area that most producers should be paying more
attention to?
I came across an investment-related book the other day called Just One Thing.
In it, a number of experts identify the one strategy they believe investors should
not overlook. In terms of farm business management, if I had to single out just
one thing, it would be to position your business for flexibility.
Flexibility will be the key to success in an era of erratic prices, costs and business
conditions, with high levels of geopolitical risk worldwide. Any successful strategic
plan needs to be able to handle the element of surprise, on both the risk and
opportunity side. The current economic environment requires a high degree of
financial discipline built upon sound and timely financial records, and a lender
with knowledge of and commitment to the industry.
Working capital and a strong capital position generated from a strong profit and
cash flow model will be critical. Let’s examine working capital. Working capital
shows the ability to generate cash within a short period of 60 to 90 days without
disrupting normal operations. Selling half of the livestock herd or machinery line
is not working capital.
Divide working capital (the difference between current assets and current liabilities)
into total expenses. If this percentage is below 10 per cent, an adverse event
influencing net earnings or an unexpected cost or expense could place your
business in dire straits. When working capital is above 25 per cent of expenses,
a business has flexibility and the ability to take advantage of opportunities on
short notice, or cope with a disaster on the downside.
Now let’s examine capital position and other financial strategies. The debt-to-asset
ratio of a farm or ranch is very critical in the flexibility game plan. The average
ratio for farms and ranches is approximately 16 per cent. Does that sound low?
Remember that one-third of farms and ranches are debt free. The typical
commercial producer’s debt-to-asset ratio is 40 to 45 per cent. Generally speaking,
a debt-to-asset ratio below 30 to 40 per cent allows a business to restructure debt
if an adverse event takes place. In the 1980s, a debt-to-asset ratio above 50 per cent
was considered a common denominator of problems for cow-calf, grain and row
crop operations.
Greenhouses, dairies and enterprises that turn their assets quickly and are
profitable can sometimes handle a ratio exceeding 60 to 65 per cent. However,
if you are in this position, be sure to have a strong working capital position
above 25 per cent of expenses and high earned net worth through profits.
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