Test Your Outlook

Test Your Outlook

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Price vs. Cost

*The following three lines are excerpted from Seth Godin’s Blog, October 16, 2017*

Price is a simple number. How much money do I need to hand you to get this thing?
Cost is what I had to give up to get this.
Just about every time, cost matters more than price, and shopping for price is a trap.

Does what Godin writes above strike a chord with you? When I hear of farmers selling out their long time input supplier to buy fertilizer for $5 per metric tonne cheaper from the dealer 20 miles down the road, I can easily understand that this is someone who does not understand price vs cost.

Expense vs. Investment

Too often there is confusion about what constitutes an expense and what constitutes an investment. An investment will provide a return over what you’ve paid, an expense will not.
Examples of investments are crop inputs, land, hired help, and quality advisors.
Examples of expenses are repairs, fuel, and equipment.
Sadly, when profitability is at risk, the first place many farmers look at is what falls under investment.

Price vs. Value

Price is what you pay.
Value is what you get.
And while it seems simple to distinguish one from the other, when emotion enters the equation we find that value is often seen where it does not actually exist.

Profit vs. Cash Flow

When I was still farming, the first year that dad wasn’t actively farming on his own any more and had rented us all his land, I was negotiating with him on when he wanted to get paid the rent (in the current year or after January 1). When he offered to defer to the new year since he had enough old crop sold already, I thanked him while admitting that it would help us since we were tight on cash for the next couple months. His reply was, “I thought you said this farm was profitable.” I told him it was, yet he wasn’t able to recognize that even though we weren’t flush with cash at that moment, we were profitable.

Often times when working with clients, I am offered a projection that they might have built on their own. Whether they call it a profit projection or a cash flow projection, it usually is a combination of both: it contains cash flow items like loan payments as well as expense items like (non-cash) depreciation. Doing so makes the result of the exercise look much worse that it actually might be.
Profitable businesses run into cash flow challenges at times; unprofitable businesses run into cash flow challenges most of the time. To rectify the issue, one must first know whether the problem is profitability or cash flow.

Problem vs. Opportunity

Recently, I read an article written by a farm advisor that described the panic of a client who hedged 30% of his new crop production at a profitable price. The panic was because the market had moved higher. His view was that this was a problem, but the advisor patiently guided him through the reality that this was actually an opportunity to price more crop.
The producer viewed the situation as a problem because he felt he “missed out” on selling for a higher price.  The reality was that he was already priced at a profit (a meager one, but still a profit) and now had the opportunity to price in even more profit. Sadly it seems he would have been happier if the market had moved down because his hedge would have been even more in the money despite the fact that the remaining 70% of his new crop was unpriced and might then be unprofitable…

To Plan for Prosperity

Objectivity can be difficult to maintain when making business decisions. I know; occasionally I have the same difficulty in my own business, and that is why I have a business advisor.

As entrepreneurs, we get caught up in what we’re doing, what we’re trying to solve, or what we’re working to create. We can get so engrossed in our own ideas that we sometimes fail to see what is blatantly obvious, that which can bring faster results, a more desirable outcome, or just less stress. Garnering the perspective from someone outside our business is a great way to test our outlook.

 

profit

Is Profit a Part of Your Strategy?

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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?

Perspective

Perspective

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What do you want to accomplish between now and Oct 1, 2018?

If I had asked many of you that question one year ago, you might have provided a response that would make you cringe using the lens of today. Last year, may farms were suffering from excess moisture, and long drawn out harvest. On this date one year ago, there were millions of acres yet to be harvested in western Canada. If one year ago you were hoping for a hot dry 2017, well…you got it.

How has your perspective changed over the course of a year? What is affecting the change in your perspective? If you’re more concerned about short term fluctuations rather than big picture issues, such as a recent market correction versus the tax changes currently proposed by our federal government, then you’re probably looking down the hood of the truck instead of down the road.

If you’re more concerned about short term fluctuations rather than big picture issues, then you’re probably looking down the hood of the truck instead of down the road.

My best client relationship has evolved from our original work of clarifying Unit Cost of Production by drilling down operating and overhead costs, so that we are now pursuing 5 year expansion strategies and establishing tactics for handing off management activities as part of a transition plan that is still 5-10 years away.

In the next breath, when asked “What is the greatest challenge on farms today,” I regretfully cutoff whoever is asking the question by blurting out “cash flow.”

I see numerous farms who do not suffer cash flow challenges. They experience the same weather, the same markets, the same interest rates. Yet somehow these farms do not suffer under the same cash flow pressure. Why is that?

Perspective.

Successful businesses have a long term perspective. Those businesses recognize the variability in the aspects affecting their business that they cannot control (like weather, markets, interest rates), and as such, they prepare themselves and their businesses for what’s coming “down the road.”

Looking down the hood instead of down the road doesn’t give you time to prepare and react to what’s coming up ahead.

Here is an easy recipe to help prepare for what’s coming up “down the road”:

  1. Understand cost of production, right down to the paperclips.
  2. Get lean in how you manage your operating and overhead costs.
  3. Maintain modest personal drawings.
  4. Eliminate unnecessary assets and the debt they bring with them.
  5. Build working capital to a minimum of 50% of annual cash costs.

By implementing these 5 steps into your action plan before spring, you will instantly be miles ahead of your competitors one year from now.

To Plan for Prosperity

There is no crystal ball in my possession, so I cannot predict what is coming down the road. What I can tell you is that I have seen the effects of business cycles on the unprepared, I have seen the effects of poor perspective on the oblivious. Conversely, I hold great admiration for the business people who had the foresight to control all that they were able to control, including how they were affected by that which they couldn’t control.

What’s your perspective?

What Do You Care About

What Do You Care About?

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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.

Systems

Systems

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Last week, we discussed the importance of adding value to your business. It hinges on knowledge that allows you to see where your business is creating value or eroding value. Without the knowledge to see where value is positive or negative, we risk making decisions that are emotional or even irrational, but always uninformed.

The key to adding value in your business comes from knowledge about the goings on in your business.

Lately, one of the more common challenges I’ve heard from clients is the challenge of accurately reconciling inventory. Yield monitors are an acceptable guess, but certainly they cannot be taken as gospel (I cannot rationalize how a machine running at high speed can provide an accurate measure of yield without stopping to calculate the mass of the grain…but I digress). Many operations have scales on the grain carts, and while this technology is much more reliable, it is useless if the information is not being recorded.  We wonder why the old adage rings true, “You never get as many bushels out of a bin as you’ve put in.” And we haven’t yet touched on inputs (seed, chemical, fertilizer) nor how you manage returns and the subsequent credits…

You never get as many bushels out of a bin as you’ve put in.

With all the technology available to accurately reconcile inventory, the reason it remains a challenge is that the system of recording and managing information is broken…if it exists at all!

Here is a small sample of the systems you need in your business:

  • Managing/tracking cash and working capital;
  • Managing/tracking inventory (production, inputs, parts, fuel, etc.)
  • Managing/tracking staff (hours, vacation, sick days, etc.)
  • Managing/tracking equipment (operating efficiency, service, repairs, etc.)
  • Controlling Unit Cost of Production
  • Creating Profit.

To Plan for Prosperity

You wouldn’t jump into your combine without confidence that all systems are in place and working properly; in fact, the manufacturers now have systems and sensors in place for almost everything making it so you can’t operate if something “isn’t right.”

There are far too many variables in your business and leaving any of them unmanaged puts your profit and cash flow at risk. With little in the way of guarantees that profit and cash flow will sufficiently meet expectations each year, isn’t it worth investing in the right systems to garner full control of your enterprise?

Adding Value

Adding Value

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To actually add value to your business you must have profit from operations. Every dollar of retained earnings that is left in your business increases the value of your business. Simple concept.

In agriculture, when someone says “adding value” we typically hear “value-added” which means something like processing, milling, refining, etc, etc, etc. Basically we infer that it is anything one or two steps up the value chain that isn’t the actual farming.

At this point, many ears close and minds drift off…

What I’m referring to today is what adds value in your business. It matters not whether your business is production, processing, or any product/service that supports your business, there are aspects where value is insufficient and it is hurting your bottom line.

What Doesn’t Add Value

  • Anything that does not provide an ROI (Return on Investment) above 1:1.
  • Anything that doesn’t provide a measurable and quantifiable improvement to efficiency (which can be translated to ROI.)
  • Anything that uses more cash that it provides.

Examples would be a brand new pickup truck, renting land that (at best) will only break-even, chasing yield to the detriment of gross margin.

What Does Add Value

  • Cash flow and expense management
  • Driving down Unit Cost of Production
  • Empowering your people

Examples would be building and preserving working capital (especially cash), understanding total farm costs relative to production, building a team of competent people who can replace you.

Defining Value

Maybe this is the place to start? How do you define value in your business? What do you see as providing value? For far too many farms, value is centered around land appreciation (a passive boost to equity) and new equipment (a major draw on cash.) Interesting how these two focus points are conflicting in how they affect a business’ financial position…

Does value comes from biggest yield, biggest equipment, biggest acreage base? Or does it come from profit, efficiency, and control?  I might be swimming against the current here, but my vote is the latter…

To Plan for Prosperity

Knowledge is key. Without knowledge, determining value becomes emotional, a guess, or a hunch… To understand value in your business requires an awareness, a level of knowledge, that does not come from gut feel. Your systems for managing the operation and all the financial decisions that go along with it are what will provide the knowledge to help you determine where you are adding value, where you can create value, and where you’re letting value be eroded away…

top producer

Are You a Top Producer?

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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)

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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.

Focus

Results Focused or Activity Focused

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Most farms will be receiving their year end financial statements from their accountants by now, if not already. Those with fiscal year ends of January 31 or later might still be waiting for their year end to be finalized.

How did your last fiscal year turn out? What were your financial results? If you are results focused, you’ll be paying attention to metrics like:

  • Net Profit
  • EBITDA
  • Gross Margin
  • Return on Equity

Activity focused operations typically don’t review financial reporting, instead directing energy towards:

  • Greasing
  • Shoveling
  • Driving
  • Anything else…

To Plan for Prosperity

There are some who will say that “money and profit aren’t everything.” Don’t listen to them. They aren’t focused on results. Yes, health and family are more important than money because money cannot buy health or a happy family, BUT without profit no one will be happy.

Profit is the fuel for your business. And like the diesel in your tractor, if you’re not making sure you have enough, things are going to stall.

farmfutures farm survival

Derived from Farm Futures “Survival Plan”

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This opinion piece was published on farmfutures.com on April 3, 2017. Titled What’s Your Farm’s Survival Plan, the author, Mike Wilson, describes how farm income in the US Mid-west is falling and thus challenging working capital to remain at adequate levels. As you have read here, and on my Twitter feed (if you follow me) is how borrowing  is becoming more difficult for US Mid-west farmers. I’ve posed the question several times is “Who thinks this can’t happen here” (in western Canada?)

Wilson lays out five practices that farmers can use to improve their chances of keeping a good relationship with their lender. Before discounting the suggestion by saying, “Yeah, well it’s different in Canada,” give it a read and appropriate consideration. Unless, or course, you believe it can’t happen here…

Snip Farm Futures Farm Survival The graphic is a screen capture of an excerpt of the article from the Farm Futures website. The text has been copied below, with my comments following each one:

What do lenders think when you walk through the door? If you do these five things, financing shouldn’t be much of an issue:

  1. Lenders will work with farmers who can communicate and execute a plan, whether it’s for marketing, cash flow, or both.
    *KG: we’ve discussed here many times over the years how important it is to communicate with your lenders who typically don’t like surprises. And while we’ve been preaching for years the value of planning, there is a key word in the statement above that, if ignored, makes planning the useless task so many farmers feel it is: execute.

2. Understand breakeven analysis and keep family living expenses low. Look for that extra dime in your marketing plan. Watch for opportunities to keep yields above average. A lot of that is just paying attention to details.
*KG: break-even analysis is one part of it. Utilizing Unit Cost of Production (UnitCOP) is critical not only to your break even analysis, but also your marketing strategy. It provides a built in sensitivity analysis to both prices and yields. It will clarify the importance of “that extra dime” in your marketing plan. It provides a level of detail that most farms still don’t employ in decision making…

3. Lenders need to know how you will pay them back. You can walk into their office, tell them about the 50 acres that just came up for sale next to your farm and expect to be approved — but that’s not how it works. They need to see that you’ve done your homework. They need to see your accurate balance sheet, income statement, accrual income adjustments, and other key financials. They need to see the numbers before they can pull the trigger.
*KG: Bankers make informed decisions; “they need to see the numbers before they can pull the trigger.” If the numbers are absent, it’s a hard stop. If the numbers are questionable, meaning that the credibility of the figures come into question, it’ll also be a hard stop. Several years ago, I witnessed a would-be borrowing get slammed by several quality bankers because the borrower provided sloppy info that was unverifiable. Lenders won’t make a decision to proceed without quality information; neither should you.

4. Be conservative with your money. “This will be a learning experience,” says Dan Gieseke, Missouri Farm Service Agency farm loan chief. “Many have not been through a tough time. They need to be conservative now, so they can be ready to take advantage of opportunities when they come along.”
*KG: The best time to be conservative with your money was 5 years ago. The next best time is right now. My old pal Moe Russell says, “If you are greedy in the good times, you’ll be on your knees in the bad times.” While shiny paint often feels better than a big bank balance, it is that bank balance (the life-blood of your business: working capital) that will not just help you survive the bad times, it will propel you through them; it’ll maybe even help you thrive during those bad times when your competitors are on their knees…

5. Use records to do analyses. “My fear is that farmers don’t use them,” says Purdue economist Freddie Barnard. “In the ’80s, we got beat up. But the tools to do the analyses then were not out there. There are tools now. Just use them, and try to make informed decisions.”
*KG: there are so many tools available, so much information available, that I would have a hard time arguing against someone who is admitting that “it’s overwhelming.” It is. While I would empathize, I wouldn’t accept that as an excuse. There are many qualified people in this industry who are ready, willing, and able to help you sort through the overwhelm, and establish a strategy to develop and implement a process to get you to a working level of comfort with data management, analysis, and decision making.

To Plan for Prosperity

“Do what you do best, and get help for the rest” is a cornerstone of my advisory work. If none of the five points above strike a chord with you because you don’t know how to do them, or don’t like doing what they suggest, then take a moment to ask yourself if the five points above are actually important to you.
If they are, but you’re not sure where to start, then start by picking up the phone and calling someone for help.
If they’re not, then good luck to you. You’re going to need it.

Your business, your family, and your legacy are too important to be left to chance.