borrowing-binge

Borrowing Binge: At The Farm and Beyond

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Last week, I was emailed an article by Rob Carrick of The Globe and Mail. Carrick writes about Canada’s borrowing binge; no not our federal government deficit and growing debt, but Canada’s household debt. Let’s see how it applies not only to household debt, but farm debt.
**NOTE: Carrick’s article is below in italics, with my comments inserted in bold.

“It’s getting harder to see anything but a messy ending for Canada’s household debt binge.

This isn’t the beginning of a lecture on reducing your borrowing. It’s more a resigned observation of human behaviour. You can warn people to act now to avoid a potentially bad outcome in the future, but they’re not likely to do anything unless they see trouble dead ahead.

The second quarter of 2016 was a vintage moment in debt accumulation. Incomes rose, as Statistics Canada puts it, “a weaker-than-normal” 0.5 per cent, while household debt growth clocked in at 2 per cent. This is the Canadian way – keep debt levels growing ahead of gains in income.

On two counts, this is bad personal finance. Your household spending flexibility is negatively affected in the short term (you have less money to save, for example), and you’re more vulnerable to financial shocks ahead, such as rising interest rates or an economic decline that kills jobs. Clearly, most people aren’t worried about these risks.”

What risks make you worried about your debt load? Can you control them (ie. fusarium, sclerotinia, excess moisture, interest rates, commodity prices?)

“The explanation starts with the fact that we live in a world in which conditions for borrowing are as good as they can ever be. Interest rates are low and the economy, while tepid, is producing enough jobs to prevent unemployment from becoming a big issue.

In the field of behavioural finance, there’s a term called “recency bias” that describes what’s happening here. People are looking at recent events and projecting them into the future indefinitely. So far, it’s working. We’ve had low rates and a slow-moving but stable economic for years now, and there’s no sign of imminent change.”

“Recency bias” describes the not so distant thinking that canola wouldn’t go below $10/bu, meaning that “$10 was the new floor” (circa 2012.) There were many other behaviors and attitudes that came with that thinking. How quickly forgotten are the years of poor quality and inconsistent yields…

“Under these conditions, there’s no reason to heed the repeated warnings from the Bank of Canada, economists, finance ministers, credit counsellors and personal-finance columnists about the dangers of taking on more debt. And so, the ratio of household debt to disposable income hit a record 167.6 per cent in the second quarter, up from 149.3 per cent in the second quarter of 2008.”

Is there a reason to heed the warnings from ag economists, management advisors, and creditors about the dangers of taking on more debt….? Depends how much debt you currently carry. 

“Recent warnings about debt levels give us an idea of what could happen if there are any economic shocks ahead. The credit-monitoring firm TransUnion said earlier this week that more than 700,000 people would be financially stressed if rates went up by a puny quarter of a percentage point, and as many as one million would be affected if rates went up by a full point.

The Canadian Payroll Association recently surveyed 5,600 people and almost 48 per cent of them said it would be tough to meet their financial obligations if their paycheque was delayed even by a week. Almost one-quarter doubted they could come up with $2,000 for an emergency expense in the next month.

These reports highlight some of the risks of the borrowing binge we’ve been on for the past several years, but not all. Decades down the road, we may find that people didn’t save enough for retirement in the 2010s because they were so burdened by debt. Student debt levels might rise in the future because parents weren’t able to help with tuition costs.”

An interest rate sensitivity test would answer this question for your particular operation. But more important that interest rates, which in reality are unlikely to experience any significant increase in the short-medium term, is income volatility. The debt payments won’t change, but a farm’s ability to make those payment will. If the debt payments can only cash-flow when yields and price are at high points, there is trouble ahead.

“That second-quarter data from Statscan show clearly how deaf people are to warnings about the dangers of debt. In the worst three-month period since the recession, economic output fell by an annualized rate of 1.6 per cent.

The reaction of employers to this economic dip can be seen in the fact that income growth was weaker than normal in the second quarter. Consumers barely flinched, though. They’re impervious not only to warnings about the dangers of high debt levels, but also to periodic bouts of economic volatility like we saw in the second quarter. Only a big shock will get their attention.

There’s no point trying to forecast when a shock will happen, but what we do know for sure is that the financial and economic conditions of today will change. We remain in an adjustment phase following the financial crisis and recession late in the past decade and it’s far from clear what the new normal will be.

Things could get better for the economy, or they’ll get worse and jobs will be vulnerable. Either way, people are going to have to make stressful adjustments that they could have avoided by reducing debt today. This could get messy.”

From the Home Quarter

It has been well documented that farm debt in Canada is high. In the next breath, there is all kinds of spin added to the argument such as stating current debt in 1982 dollars so as to compare to the carnage that was beginning 34 years ago. Not to try to deflate the validity of constant dollar comparisons, but the cold hard reality is that existing debts, today’s liabilities, need to be paid back. Compare the situations all we like, describe how “things are different now;” either way, no matter how you slice it, current farm incomes need to pay present day debts.

So when I hear of lentil yields often coming in at half of expectation, when I hear of wheat and durum crops again decimated by fusarium, when I hear of malt barley crops grading as feed because of all the rain, I can only hope that those farms who experience such production results this year are not over-leveraged. Is this a hint of “the big shock” Carrick wrote about, as it would apply to agriculture? Or is that big shock something already on the radar like China slamming the door on Canadian canola that doesn’t meet spec?

The borrowing binge at the consumer level, as Rob Carrick wrote about, could have drastic implications on the Canadian economy; his words also apply to agriculture. We could be in for a rough ride, “this could get messy” as Carrick wrote.

Sage words from a 30+ year farm advisor: “Take your worst net income over the last 10 years and measure it against today’s debts. How do you feel?”

If you don’t feel good from that experiment, please call me or email for strategies to help ease the discomfort.

Overspending

Critical State – Overspending

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Cash in the bank is a good thing. Spending it because it is there is the scourge to many farm’s financial strength.

Years ago, when I was still in banking, I was doing what can be argued young bankers should, or should not, do…I was listening intently to some well tenured, long-in-the-tooth bankers. It was good because of the insights they brought. It was not good because of the cynicism they had. One cynical comment in particular stayed with me; it was when that grizzled old banker said, “Farmers hate having money in the bank…as soon as it’s there, they go spend it!”

Maybe that comment showed his lack of insight into how a farm business is run. Maybe he was fairly accurate in his conjecture in how it relates to the psychology and mindset of a farmer. Although, I believe that “hate” is the incorrect descriptor for how farmers really feel about cash.

You may recall reading Spending Less is More Valuable Than Earning More in this commentary a few months ago. I regularly read comments in ag publications and on Twitter about how “farmers are good at making money, but trying to keep some is the hard part.” Not for everyone…

Investing in your business is something not to be taken lightly. Every year, month, week, and day, farmers battle with the decisions of what to grow, how to fertilize it, what to spray, when to spray it, etc. With almost the same frequency, many farmers are also looking at the tools to get the job done (ie. farm equipment.) “Newer, bigger, better” seems to be the name of the game when it comes to equipment. And less frequently, farmers consider expanding the land base. Whether to rent or to purchase is but one of the questions pertaining to land.

It is my belief that the issue of overspending would not be an issue if more discipline was used in ensuring that all expenditures met an ROI (Return on Investment) threshold. I’ve learned about the following instances in the last year that clearly show a lack of understanding the concept of ROI:

  • disastrous chickpea crops despite as many as 6 fungicide applications (at $15-$20 each, that’s an extra $90-$120/ac in inputs)
  • $90/ac rent paid on 640 acres that has only 420 acres available in the entire section due to excess moisture (so he’s actually paying $137 per cultivated acre)
  • inability to make loan payments because the operating line of credit is maxed out.

I have gone on record many times in my prognostication that credit, specifically operating credit, will be difficult to maintain (and likely impossible to get) in the not-too-distant future. Those operations that do not run on cash, therefore relying on operating credit, will face insurmountable hardship when credit policy changes.

Control your own destiny:

  1. Build working capital reserves, specifically CASH;
  2. Discontinue relying on operating and trade credit to cash flow your farm;
  3. Sell your production when it meets your profit expectations instead of when you need to make your payments (cash in the bank allows you to do this!)

Direct Questions

How would you describe the rationale employed when determining how to deploy resources, specifically cash?

As a percentage of your annual cash costs, what is your minimum cash balance to keep on hand?

From the Home Quarter

In a business within an industry that is renown to have multiple cash and cash flow challenges, it is not unusual to learn that adequate (or abundant) cash on hand is not common. And so when cash is available, the need (or temptation) to upgrade this or replace that can be too much to handle. Disciplined decision making, backed by a sound strategy, is often the difference between successful, highly profitable farmers and surviving, occasionally profitable farmers. Which would you rather be?

For guidance, support, or butt-kicking in developing your strategy, and the discipline to stick to it, please call or email my office.

canola field

Critical State – Debts Get Called

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Imagine, if you will, that it is a nice harvest day in late August. The combines are serviced and running, warming up to head to the field. You’re in the house grabbing a quick bite and filling your water jug before embarking on what looks like a long afternoon of harvesting. The phone rings, it’s the bank. They tell you they’ve made the decision to reduce their market exposure in ag lending in your area, and that you’ve got 30 days to “find a new lender.”

While I hope this is an imaginary situation for most of you, it is a true story for a client of mine from my banking days. It wasn’t my bank that “de-marketed” them; that happened years earlier, but it left a sour taste in their mouth. They had cash flow challenges like almost all grain farms did coming out of the 90’s, but their file was not at risk of going south. There was no indication in the previous weeks or months that their loans may get called, so you could only imagine the shock, the disappointment, and the anger at getting that type of phone call at the beginning of harvest. How could they find the time to seek a new lender when the combines had to roll?

Here are some terms that borrowers need to understand:

  1. Demand Loan: this is a loan that provides the lender with the right and opportunity to demand full repayment of the loan at anytime. While there still may be time remaining on the loan term, notice of demand to repay the full balance is an option the lender can exercise.
    Structuring your borrowing to include no demand loans does not guarantee that you wouldn’t face a situation as described above. Demand loans are typically listed as a current liability in your financial statements which makes your working capital look offside.
  2. Effective Annual Interest Rate: interest payment terms, specifically interest compounding periods, affect the actual dollar amount of interest you pay on a loan. Interest that is compounded more frequently will cost more than less frequently (this also applies to your interest bearing investments: more frequent compounding pays you more interest and vice versa.) Lenders are required to calculate and disclose the annual effective rate so that borrowers can have a standardized figure to compare.
    Consider 5% interest compounded semi-annually; the effective annual rate is 5.0625%. Consider 5% compounded quarterly, and the annual effective rate becomes 5.09453%. The difference between the posted 5% and the annual effective rate in these two examples is the compounding interest.
  3. Covenants: as the term implies, covenants form part of the binding agreement between you and your lender. Breaching a covenant could put your total borrowing at risk of being demanded by your lender. Covenants can be for anything from minimal financial metrics to submitting financial reporting. Sluffing these off will hurt your lending relationship.

Direct Questions

What information do you require from your lender to give you more knowledge and comfort?

How are you being proactive in managing your relationships with your lenders?

From the Home Quarter

Receiving notice that your debts have been called instantly puts your business at critical state. While having an excellent relationship with your lender does not guarantee that you won’t be the victim of a corporate de-marketing decision (like my former clients above,) it will put you at the top of the list of clients to keep if there is ever a culling program initiated by bank HQ.

go fishing

If You Are Happy Just Floating Along, Go Fishing

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I wasn’t trying to be funny when I quipped what is the title of this commentary while in a meeting with an excellent banker and the exciting young prospective client he introduced me to. It just sort of rolled off my tongue in the moment. It was a hit; both men enjoy fishing.

The premise of that particular conversation was profit. In my work as a lender and a consultant, I venture to say I’ve looked at hundreds and hundreds, maybe thousands, of financial statements. Those statements have told a vast array of stories, from the depths of successive and devastating financial losses to the opposite end of the spectrum with profits that make you wonder if your’re drunk when reading it. Many hang around the middle, somewhere south of an impressive profit , but still north of a fundamentally adverse loss. It is sad to discover than many farmers create this break-even situation by choice.

The choice is often centered around tax and the great lengths taken to avoid payment of income tax. The list is long and arduous; it won’t be found here.

Let’s put this in real terms. Most farms I’ve analyzed range from approximately $250/acre on the low side to $400/acre (or even higher) as the figure that represents whole farm cash costs. That is the amount of cash required to operate the entire farm for one full year. Now, I got my math learnin’ in a small town school, long before calculators were allowed in the classroom, back when cutting edge computer technology was the Commodore Vic 20, but math is math, so if we consider a 10,000ac farm with $400/ac costs, we’re looking at $4,000,000…each year!

Granted, there aren’t too many 10,000ac farmers who are happy to break-even each year, but they are out there. At the end of the day, I don’t care if you’re 400 acres or 140,000 acres, expect a profit!

Farmers take far too much risk each year to not expect a profit. If you walked $4,000,000 into any bank, could you get a better return than 0%? Of course! You could get a risk free rate in GICs that would probably approach 3% (or maybe 4%…any bankers reading this what to comment???) So I ask why, if you could get a risk free rate of 3% or 4%, why would you take a sh_t-ton of risk to accept a 3% or 4% return farming?

Direct Questions

Investing $4,000,000 in GICs and getting a risk-free 3% annual return grosses $120,000 per year before tax. Could you live on that?

Land owners/investors demand a rent that mimics 5% return on the value of the land. If you invested $4,000,000 in land, you could earn upwards of $200,000 gross in rent, plus enjoy the long term capital appreciation…could you live on that?

What is an acceptable return to demand from your business…based on the amount of risk you take each year?

From the Home Quarter

Farming is not for the faint of heart. Farmers accept the financial risks that come with farming because they understand them. The opposite if often true of stock markets: farmers aren’t typically investors in equity markets because generally they don’t fully understand the risks. But savvy stock investors who do understand the risks still expect a positive return, they aren’t happy “just getting by.”

If you’re happy just floating along, go fishing.

If you expect to get well paid for the risks you take, call me.

 

toe the line of critical state

Critical State

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Critical State…it’s a subjective term, but is often defined in science literature as “the point at which something triggers a change in the basic nature or character of the object or group.” To paraphrase: something can be referred to as being in a critical state when at the point of significant change.

How many triggers of change do you, your family, and your business face each day, each month, and each year that could cause significant change? How many ways are you riding on or near the line of a “critical state?”

While there is little doubt that the list could be far longer, here are ten of the most important circumstances (many of which are ignored) that could put you at, or beyond, a critical state:

  1. Disability or Loss of Life: whether it be one of the major stakeholders in your business, a member of your family, or one of your employees, this is often the most catastrophic change.
  2. Lack of a Succession Plan: see point #1 above.
  3. Inability to Communicate: with family, partners, employees, vendors, etc.
    Does any more need to be said on this one?
  4. Debts Get Called: sometimes lenders make adjustments to their portfolio to manage their risk. If your debts get called, how do things change for your business?
  5. Overspending: cash in the bank is a good thing. Spending it because it is there is the scourge to many farms’ financial strength. Do you believe cash is king?
  6. Crop Failure: do you have the financial strength to survive a crop failure?
  7. Timing: trying to time the commodity markets is almost like trying to pick winning lottery numbers; both are nearly impossible. Regarding major purchases, there clearly is a right time and a wrong time to be taking on more debt, investing in more or upgraded assets, expanding, etc.
  8. Inaction: not monitoring bins, too cold to haul grain, we’re at the lake (can’t scout for bugs/disease,) etc. Poor excuses that can quickly create a critical state.
  9. Maintaining Inadequate Working Capital: believe it or not, but the chronic dependence on operating credit from lenders and vendors leaves a farm at the precipice of a critical state. Operating credit should not be counted on year over year. What if it isn’t there when you needed it most?
  10. Unwilling to change and adapt: “We’ve always done it this way,” are the 6 most deadly words in business.

Direct Questions

How many of the 10 points above might apply to your farm?

How would you gauge your ability to critically analyze your own business relative to the 10 points above?

What is your strategy to remain “well back” of the line that crosses over into critical state?

From the Home Quarter

In the battle against weather, insects, disease, market prices, etc, it is easy to get caught in a routine. When we succeed at managing through the day to day, the “extra” stuff, the “other” issues seem like they can wait. “It’ll never happen to me” are some of the most famous last words.

Too often, we operate at the very brink of critical state. Too often, we get away with it, which allows to be become “something we’ve always done.” So I’m left to ask,”Isn’t it better to avoid a crisis than deal with one?”

 

cash is not king

Cash Isn’t King

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I think this phrase has gained such popularity because of alliteration. The hard “c” in cash just rolls with the word “king.”

Let me emphatically disagree with the ideology that cash is king.

One could argue that the king rules all, answers to no one, and has absolute power. While I’m sure that is what the king would have everyone believe, the truth is that kings have always been influenced by the likes of his queen, his advisors, other diplomats, etc. Is he, then, truly the top, unflappable, incontestable?

Since we live in a democracy and are no longer ruled by a king or queen, when I hear such terms I think of cards. The card games I enjoy the most are 3-Spot (also known as Kaiser) and Poker. In both games, the king is soundly trounced by one card that is even greater.

Yes, I’m saying it.

Cash is not King.

It’s the ACE!

If cash is king, then that means that something else is the Ace, something else is more important than cash. This is simply not so.

Cash is the ace, the pinnacle, the life blood of your farm.

Imagine how the decisions would be different, the decisions that are made every day and every year on your farm, imagine how they would be different if you had an abundance of cash:

  • Instead of gambling on trying to time the commodity market high, you could sell your production whenever was most convenient and/or at an appropriate profit point.
  • You would cease the need for operating credit, vendor credit, or cash advances.
  • “Cash management” would no longer be juggling between various creditors and hoping you can deliver grain in time to make payments, but instead it would be paying bills on time (ahead of time?) and selling grain when it made the most sense.
  • Risk management programs would be a non-issue.
  • Equity loans to recapitalize the business would be a completely foreign concept.
  • Acquisition decisions (land, buildings, equipment) would be easier, faster, and more empowering.
  • YOU’D HAVE LESS STRESS!
    (That is capitalized for a reason.)

Cash is the Ace. It ranks above precision planting, Group 2 resistance, or the latest technology trends. The Ace outranks the King; it outranks all the other cards.

Direct Questions

Has cash always been your Ace, or have other things become more important?

What are the top three benefits to you and your business if cash was abundant?

How confident would you be to have TWO Aces in your hand?

From the Home Quarter

We often regard agriculture as doing amazing things with scare resources. Cash does not have to be one of those scarce resources even though that has been the mantra for generations (a.k.a Asset Rich – Cash Poor). Assets do not pay bills, cash does. The desire to convert cash into assets needs to be squelched at a time when debts are high, cash flow is tight, and profit margins are narrow.

Since cash is the life blood of your business, and a critical contributor to your financial health, when is the last time you had a checkup?

With your year-end financial statements now done, you’re ready for a checkup. Email your financial statements to me and I’ll provide you with a financial health report card. Normally a $500 value, this service is free if booked by June 13, 2016.

 

dichotomy

Dichotomy

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Here is a throwback to an article I wrote in August 2015 titled Is Data Management Really Important? where I highlighted a conversation between a friend and I that included his opinion that even large corporations let their “focus (be) primarily growth & profits and how to accomplish it, with information management being thrown together afterwards.”

While I believe that statement to still be true both for large corporations and farms alike, there is something in that statement that opens up what seems to have become the dichotomy of prairie grain farming: growth or status quo.

Let’s not get hung up on “growth’ as a single definition. In March 2015, my article Always Growing…Growing All Ways clearly described a few of the many ways we can achieve growth in our businesses that does not have to be pigeon-holed into the category of “expansion.”

So let’s clarify the dichotomy as “expansion or status quo.”

Now let’s compare a couple different scenarios.

  1. In the spring of 2016, I met with a young farmer who started out in 2000 with nothing but an ag degree and desire. As he prepared to sow his seventeenth crop this spring, he showed me his numbers while admitting that he felt good about his financial position, but didn’t really know if he was good or not. He lost almost 20% of his acres from the previous year, and was happy about it because the cost to farm that land was too high and he knew it.
    When I told him that I’d peg his operation in the top 10%, maybe even the top 5% of all grain farms on the prairies, he paused and said,”OK, so what are the top 5% doing that I’m not?”
  2. There is a farmer who has been calling me off and on for a couple years now. By all accounts, it is quite a feat that he is still operating. Although he’s been farming for well over 20 years his debts are maxed out, leases are burning up cash flow faster than the Fort McMurray wildfire is burning up bush land. He spends more time running equipment that his hired men; he has no clue what his costs are; he has aggressively built his way up to 10,000ac and wants to get to 20,000ac; one of his advisors told me that his management capability was maxed out at 4,000ac.

The first scenario has the farmer focused on growth of profitability, control, and efficiency.

The second scenario has the farmer focused on growth of the number of acres on which he produces.

One would be the envy of 95% of farmers.

The other will never in his entire career get to the point of financial success that the first farmer has already achieved.

Direct Questions

Which are you more like, the first farmer above, or the second farmer?

Which farmer do you want to be like?

What are you prepared to do to get there?

From the Home Quarter

What has been described above is actually a false dichotomy. We’ve been led to believe that farms must get larger in order to survive and that small farms were doomed. What that message failed to deliver was “At what point is a farm large enough?” I am not decrying large farms or the continued expansion of farms…as long as it makes financial sense! The false dichotomy of expansion or status quo need not be black or white, left or right, mutually exclusive. Farms that are not expanding today could be expanding next year, just like farms that are expanding today may not be next year. Some farms that have expanded over the last few years might even be looking at reducing acres in the future.

Growth (expansion) at all costs can often come with the heaviest of all costs.

trickledown effect of too much debt

The Trickle-Down Effect of Too Much Debt

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One would think we learned something from watching the US housing market collapse at the end of the previous decade. Yet, here we are, seven or so years later and many are making the same mistakes that were made by countless US homeowners.

Granted, the macro factors that helped to create the US housing crisis are not prevalent here in Canada. My favorite term from the US crisis was “NINJA” Mortgage: No Income? No Job? …APPROVED! Lending criteria in Canada isn’t quite that liberal.

What exacerbated the problem in the US was how homeowners were using their homes as a personal ABM, taking cash out whenever they wanted for whatever they wanted from the rapidly growing equity they had in their homes because the house values just kept increasing. They leveraged the “found” equity they had in their homes to feed their consumer appetite.

Here in Canada, and specifically farms on the Canadian Prairies, we’ve seen something similar. Rapidly appreciating farm land is being used to secure more borrowing, and often to secure the consolidation of other loans. The renaissance of farmland value appreciation, especially in Saskatchewan, added a dangerous amount of fuel to a fire of pent up demand. Land “equity” was used for the feverish acquisition of equipment, buildings, and more land.

In the US, while sub-prime mortgages kept payments low, everyone was happy to be ticking along with borrowing and spending to their heart’s content…until the sub-prime period ended and the piper needed to be paid. With a property fully leveraged and no ability to repay the debt, many homeowners resigned themselves to foreclosure. Those who may have had an ability to pay the debt saw the value of their fully leveraged property start to decline because of all the other foreclosures, so when they found themselves underwater, they too went the route of foreclosure.

No one is arguing that things are different here. True. Borrowing criteria is more stringent in Canada. What is similar, however, is the experience of a rapid appreciation in the value of real estate and the leverage of said appreciation to support more (other) debt.

I was talking with a 17,000ac farmer recently who was very aggressive in expansion over the last several years. He has increased the size and scale of his farm in every way: land, equipment, labor, and debt. He made no bones about continuing to leverage all assets, including the appreciating land and his depreciating equipment, to the fullest extent in an effort to facilitate further expansion. The scourge of his actions over these last few years was the incredible drain on his cash flow to service all this debt. This came to light for him when recently he needed land equity to source an operating line of credit so that he could meet his debt payments.

Direct Questions

Have most of the increases to equity on your balance sheet come from appreciation of asset values or have they come from building your retained earnings?

How has your Debt to Net Worth changed over the last few years?

Are you drawing on your operating line of credit to make loan payments?

From the Home Quarter

It amazes me how what was ingrained into our long term memory for so long was so quickly forgotten. The memories of the indescribable hardships of the 1980s and 1990s have seemingly been overtaken by the boom years of 2007-2013. The willingness to replace the history lessons of tight margins and poor cash flow with the euphoria of big profits and cash to burn has led to many farms now facing a debt and cash crisis similar to what was common in the final 20 years of the last century.

The trickle-down effect of debt stems from when debt levels increase as fast as, or faster than, the borrower’s long term cash flow and net income. While asset levels increase, sometimes very rapidly, tremendous growth in debt levels eat away at potential equity and use up available cash flow. While the land base has expanded and late model equipment efficiently farms all the acres, while the bins may be full and the employees are busy, it all trickles down to cash.

When the demands on your cash are a raging river, it is pretty hard to live on a trickle.

 

 

Spending Less

Spending less is more valuable than earning more….

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Let’s start with a handful of truths:

  1. You need to spend more to earn more, but it is incremental such as…
    • When you go beyond the exponential benefit (spending $1 extra to earn $2 more,)
    • When you move into the realm of linear benefit (Earning $1 for each $1 you spend,)
    • When you push on and find yourself in a negative benefit (each $1 spent earns less than $1 return)……we may have reached the beginning of the end.
  1. Earning more leads to spending more.
  2. In what is our “consumer society,” we are driven to spend more.

 

Ok, so let’s expand a bit for some clarity.

Spending more to earn more applies to your crop inputs.
Does investing in a $200/ac fertility plan earn you more than $200/ac above what you’d earn without any fertilizer? Of course it does. How much more…have you figured it out?
If spending $20/ac on fungicide can earn an extra $60/ac in revenue, it’s a no brainer. Can it? If you expect to yield 40bu/ac on a wheat crop, will that $20 fungicide earn you a $1.50/bu premium? What’s the spread between #2 and Feed? If it is $1.50/bu or less, why invest in the fungicide?

When we earn more, we spend more. It’s just the way it is. Does it have to be this way? No, of course not, but in our consumer society where we need instant gratification, usually achieved with retail therapy, our consumerism appetite is nearly insatiable. We’re all guilty of this to some extent…even me.

The title, “Spending less is more valuable that earning more” is a line I read in an Op/Ed piece and that line is attributed to Andrew Tobias from his book The Only Investment Guide You’ll Ever Need. I have not read Tobias’ book, so I cannot offer anything on his intention or his message. What I can do is share some of my perspectives on the realities of how we spend.

  • “I just got a raise, so let’s go out for supper. I’ve never had escargot before, but hey, I’m earning more now, so why not?”
  • “We just closed that deal and it will put me over the top for the bonus I’ve been waiting on. I’ve had my eye on that Ferrari for so long…paying off my line of credit can wait until next bonus!”
  • “Wow, we’ve had a banner year! We’ve never seen this kind of cash flow before! Interest rates are so low. I bet I could get a deal on a new <shop/tractor/combine/etc.>

From my days at the bank, I saw a client pay approximately 10-15% more than market price for land, and then 1 year later, pledge to buy a brand new combine with cash. At the time, their working capital was adequate, not especially strong, but it was adequate. They were prepared to use up all of their working capital to buy this new combine because they had a strong year (and felt that many strong years were to come.) I gave them good advice: do not use up your cash to acquire a depreciating capital asset. As a thankyou, they didn’t even give me the loan (they went to another lender.) The very next year, they got hammered with excess moisture and were a breath away from getting all their loans called. Imagine if they hadn’t taken good advice!

Early in my banking career, I heard a grizzled old banker say “Farmers hate having money in the bank; as soon as it’s there, they spend it!” Recently, I listened to a very progressive farmer admit to keeping a set balance in his operating account by shifting excess cash out to a savings account. His rationale: if I don’t see it I won’t spend it; I know it’s in another account, but I don’t track it like my operating account so it’s not available to spend on something I really didn’t need!”

Beautiful!

In our chase to “earn more” we can easily get caught in a cycle of working harder & longer, and investing (spending) more in our business in an effort to boost revenues. Yet the tradeoff of return versus investment must be considered. Investment isn’t just monetary.

Just the other day, I was talking with a client who is considering adding an enterprise to his farm. (For the sake of confidentiality, I won’t give more detail than that.) This new enterprise would very likely bring significant positive cash flow to his farm and family, with very manageable new debt required for equipment to perform the work. He is a strong relationship marketer from previous work outside of farming, so “business development” isn’t a risk for him. The question I asked, the question he couldn’t yet answer, was, “How much time are you prepared to take from your farm and your family for this venture?” His investment wildcard is “time.”

Direct Questions

We’ve discussed ROA and ROI in the past. How are you implementing a reasonable “return” for your investment in inputs, assets, and time?

How would you feel to have 1/10th of your net worth sitting in the bank as cash? That’s $1million in cash on a $10million net worth. Would that burn a hole in your pocket, or give you a calm and serene sense of security?

Where is your mindset when it comes to generating profit: is it from increasing revenue or decreasing expenses…or both?

From the Home Quarter

Andrew Tobias has received many accolades for his writing, and he was the one who wrote “Spending less is more valuable than earning more.” If that applies in a practical sense or not, we could argue all day by bringing up economies of scale, leverage, and tax rates. I am contending that it applies to a mindset of earning a profit and hanging on to it, building those retained earnings, establishing that “war chest,” and setting yourself and your business up for riding out the rough spots in the economic cycles.

Taking all your profit from the last go-round and reinvesting it all on the next one has a place.

It’s called a casino.

 

 

Renting Farmland

Are You Renting Farmland?

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An online article published by Country Guide about land rent contained some points that many of us have pondered. Much of the article centered on a lack of useful data on rented land, such as recent crop rotation & yield, pest pressure and pest management, soil type, residual fertility, or recent rental rates.

While this poses a challenge to those who insist on making the most informed decision possible, recent history indicates that the appetite for more land to increase a farm’s size and scale has grossly overshadowed rational analysis when making a decision whether or not to rent a piece of land. The article quoted a 2012 survey that was funded by the Saskatchewan Ministry of Agriculture which tabulated approximately 2,000 cash and share rent agreements. The article reads, “The company hired to do the survey found an astonishing range of rental rates, ranging from an almost unbelievable low of $6.25 an acre to a high of $140.60 an acre.” It’s probably fair to say that $6.25/ac isn’t “almost unbelievable,” but straight up unbelievable. My vote is that some wise-guy wanted to skew the data and provided a false figure. It’s the high figure, the astronomical $140.60/ac, that is the head-scratcher. I have lost count of the number of pencils I have used to try to pencil out a profit at that rental rate. It requires the perfect storm of yield and price to marginally make it work. The guys paying this kind of rate must have some sort of magic pencil I have yet to find.

Here’s where it really gets good. Another excerpt in this CG article reads, “In the short term, taking on more land that won’t necessarily pay for itself might still be a winner in the farmer’s eyes in that light, especially if it allows them to spread fixed costs and labour costs over a larger land base.”

So let me take a shot at paraphrasing:
“Our fixed costs are really high, so in order to justify the bad decisions we made when we took on too much debt and allowed other fixed costs to rapidly increase, we will make another bad decision by overpaying for land that won’t make us any money so that it makes our fixed costs look better by spreading them out over more acres.”

What?

OK, that was wordy, let me shorten it:
“We’ve got all this equipment so we need to run it over more acres to justify having it.”

Still too long and soft? Alright, one more try:
“Pride is more important that profit.”

Eww, ouch! That stings!

But if the thinking is that we must take on more land in order to justify high fixed costs (usually for shiny new equipment) then it is clear that the pride of possessing such equipment and the pride of farming “x” number of acres is more important that being profitable!

Here are my 3 “Growing Farm Profits” Tips for renting land:

  1. Know your costs.
    By knowing your costs, you can easily determine what is or is not a reasonable rent to pay and still remain profitable. Without knowing your costs, you’re shooting from the hip…in the dark.
  2. Invest in assets in the correct order.
    Taking on more equipment than you need, then frantically trying to “spread it out” over more acres to justify the decision is backwards. It’s like buying a seeding outfit before buying a tractor: you might end up paying more for the tractor you need, or buying more tractor than what is required because of a lack of available selection. Secure your horsepower first, then find the drill to pair to it.
    Secure your land base first, then invest in the iron to work it.
  3. Nurture your landlord relationship.
    Let them know how your year was. Explain your farming practices. Help them understand how profitable their land really is. This goes a long way to establishing goodwill at renewal time.

Direct Questions

How much at risk is your working capital if your fixed costs are too high?

What steps are you taking to ensure your investment in rented land accentuates your profitability and not diminish it?

Is the goal to be the biggest or the most profitable?

From the Home Quarter

“Better is better before bigger is better” is a phrase that I hang my hat on quite regularly. While I cannot take credit for coming up with that one, it is so remarkably accurate in its simplicity.

If we can all acknowledge that threats to working capital should be our greatest concern in the short-to-medium term, then we must also acknowledge that adding unprofitable land in an effort to justify fixed costs will only accelerate the bleed of precious working capital.