When my advisor instructed me to write, weekly at a minimum, I eagerly said, “Okay!” even though it sounded terrifying. And it was, at first, but it then became my medium for much of the stuff that had been ruminating around in my head over the years to have someplace to go. It wasn’t a chore on the “To Do” list; it was simply part of the routine.

But now it’s time to get on down the road. I’ve been hired to take on a project that will keep me from maintaining this weekly commentary, and while I will miss this piece of what has become my weekly routine, my change in direction is what I need right now.

So while this may be the last new piece of commentary produced by me, there are 190 others archived for your perusal at your leisure.

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Time to Get On Down The Road…

Who sets the direction for your business? Without direction and a charted course, your business is akin to a rudderless boat, just floating along aimlessly. While “floating along aimlessly” sounds like a great vacation, it is most definitely not a strategy for your business.

Direction is set by the leadership team within the business. Big or small, any business without solid leadership, visionary decisive leadership, will find it very difficult to achieve its full potential.

This is why great leaders are well known, highly regarded, and abundantly compensated.

This reality crosses into all aspects of life, not just business. Sports, politics, religion, even in households, the same can be said. Every organization, even volunteer advocacy and/or charity groups have a designated leader…someone who sets the direction for the organization, or in the case where there is a board of directors (or something similar) the leader is accountable for the execution of the strategy and direction for the organization.

Nowhere is the accountability of the leader more public than in professional team sports. Anyone who is fan of any team sport can think of a time where their favorite team, or another team in the league, has went through the turmoil of having a talent laden roster of athletes that habitually fails to succeed. Often, all it takes is a change in leadership, the head coach or general manager for example, and the team begins to win. The leadership can also be identified in the locker room among the players; adding a player with tremendous leadership attributes can be as beneficial as cutting a player who brings a toxicity to the locker room. As fans, we all witness these personnel transactions and then complain or celebrate accordingly (depending on our own view of the matter) but it is a test of the team’s leadership to make the decisions to essentially “fire” a coach or player who may be popular from the outside looking in, but is a detriment from the inside looking out.

This example applies to your business as well. While it may be hard to justify letting go of a star member of your team, if that individual is not conducive to team harmony and progress it falls on the leader to make, or not make, the hard decision. Either way, the leader has provided a clear message to the entire team through their (in)action.

What is even harder is when the person that needs to be let go it the leader himself! Are you holding your team back from achieving their full potential? How would you even know if you are? Could you handle hearing that the problem is you, or would pride get in the way? It is a wise and humble leader who recognizes that the best move for the organization might be to fire herself.

Plan for Prosperity

Whether you believe that leaders are born or leaders are made, an organization without a leader is an organization without direction. Without direction, a business lacks purpose. Without purpose, a business lacks the ability to make progress. Without progress, a business becomes redundant. Look no further than Kodak or Blockbuster Video for real life examples.

As the leader of my own business, I hold the accountability for decisions (good or bad,) results (good or bad,) and overall direction & strategy. As the leader, it is up to me to adapt when things change because, as they say, “The only constant is business is ‘change’.”

Prophetic words that apply to every business and simplifies the importance of profit.

Profit Margin is calculated as “Net Profit” divided by “Gross Revenue.” Essentially this calculation tells you how much of every dollar earned in gross revenue is actually profit. The smaller the profit margin, the less you keep.

It goes back over 10 years now to when I was a bank branch manager in a rural community. A client was trying to purchase a lake cottage and was upset with us that we weren’t clamoring to provide them with a mortgage. They worked very hard in their business that provided a service to the oilfield, and had expanded it several times by adding more trucks and employees. In one of their rants on me for not giving them what they wanted (it was more like “demanded” at this juncture) one of the partners (a married couple) said, “What does it take? We made a million dollars last year!” True, their top line revenue was exceeding $1,000,000 in the previous fiscal year; however, their net income – the profit – was just over $15,000. Even adding depreciation and interest back into the calculation (to arrive at EBITDA) there was no way they could service the mortgage they were requesting. Their profit margin was (in a simplified example) 0.015%, which meant that for every $1.00 in revenue they generated, they were retaining $0.015 in profits (1.5 cents profit for every dollar in revenue…hardly sustainable in a cyclical industry.)

What I Don’t Like About Profit Margin

1. There are many variations on the calculation:

• gross profit margin
• operating margin
• pretax profit margin
• net margin…just to name a few. Each of these is measured slightly differently and has different meaning in different circumstances. If there isn’t sufficient care in assuring accurate nomenclature, things can get confusing.

2. The calculation, on face value, includes the non-cash depreciation expense (a tax figure) that often does not accurately portray the true market depreciation of an asset.

What I Do Like About Profit Margin

When calculated consistently over time, the trend will open up investigation and discussion on variances year over year (YoY) so that corrections can be made if necessary. I also like that it can be an internal benchmark, your own personal KPI (Key Performance Indicator) to which you could measure actual profit margin results against an ideal profit margin target that would fuel your business goals and growth aspirations.

Plan for Prosperity

What is a sufficient profit margin in your business? It is often relative to the industry in which you operate. If you have no idea, a good person to ask is your banker.

After spending virtually all of my professional career working on the financial and business aspects of agricultural production, I can confidently say that western Canadian grain farms need to target a 20% profit margin to sustain their businesses through the volatile cycles that affect the industry. “Target” because some years will blow right by 20%, other years will be low single digits (or negative numbers.) This truly is one space where bigger IS better!

Where has your profit margin measured out over the last 3-5 years? Which way is it trending? Why? If you don’t know the answers, or haven’t asked the questions, there is no time like right now to dig in.

If your business isn’t recession proof, here are a few tips to help you mitigate the effects of a recession and survive the downturn…maybe even thrive during it.

Bullet Proof Your Balance Sheet 

A strong balance sheet is your best weapon in fighting the effects of a recession. This also means keeping balance in the balance sheet, specifically top vs bottom, not just (left side and right side) assets vs liabilities. Top vs bottom means focusing on current assets and current liabilities (I.E. your working capital -the top half of the balance sheet), and not just accumulating assets and equity (the bottom half of the balance sheet.) Too often, I’ve seen businesses punish their working capital in a race to retire long term debt. While creating that equity by reducing debt is great, if it costs you your strength in working capital, it isn’t making your balance sheet bullet proof. Bullet proof is strong equity AND abundant working capital.

“Bullet proof your balance sheet during the good times, so you can catapult ahead of your competitors during the bad times.
If you get greedy during the good times, you’ll likely be on your knees in the bad times.”
– Moe Russell

Trim the Fat

Where in your business have things gotten a little complacent? Where is your business over-equipped? What can be identified in your business as “nice to have” instead of “need to have”?
When business is good it becomes easy to let things slide, to acquire equipment that helps things along but isn’t necessary overall, to treat oneself in ways that weren’t affordable before. It’s human nature, it happens, but it’s not sustainable in business that faces recession.

It is the business owner’s/manager’s obligation to scrutinize assets and processes for opportunities to get lean. And getting lean BEFORE the recession, before the business is forced to make reductions, is far easier than when the situation has become dire.

Is making a change to diet and exercise easier and more beneficial before a heart attack (I.E. prevention) or after (I.E. recovery)?

Be Responsive

We’ve all heard it before, and have probably said it a time or two ourselves: things will get better, they’ll turn around, just give it time.

Famous last words?

No one can accurately and consistently predict how long the market cycles will last. Many think they can, but they can’t. So if your business generates results that do not meet expectations, doing nothing about it is sure to repeat the same results. How long can your business not meet expectations during a recession? If we knew how long the recession would last, we could answer that question confidently, but we already acknowledged our inability to prognosticate market cycle duration. The solution then becomes, “do something about it.”

If revenue was below target, find out why.
If profit missed expectations, find out why.
If your best employees have resigned unexpectedly, find out why.
Waiting for divine intervention to “turn things around” is rarely a successful plan.

Plan for Prosperity

The advice above does not only apply to preparing for an economic or market recession; it applies to big picture planning in your business as well. Because it doesn’t take macroeconomic factors to have an impact on your business, putting these actions in play anytime will prepare you and your business for the unforeseen hazards that can throw your best laid plans into the ditch.

If you want to “Be Better™” is starts with “being ready.”

The Asset Turnover Ratio is one of my favorite metrics, especially when working with farm businesses. Despite what one may infer by the name, this ratio is not a promotion of turning over assets any faster than they already are. Quick turnover of assets is a major contributor to profitability challenges and cash flow challenges in the farm space.

In brief, the Asset Turnover Ratio is a measurement of how efficiently a business uses its assets to generate revenue. The calculation indicates how many dollars in revenue are generated by each dollar invested in assets. Higher is better.

The classic (textbook) version of the calculation is “Total Revenue” divided by “Average Total Assets.” So if your business generates $2.5million in revenue with $1million in average total assets, then your Asset Turnover Ration (ATR) is 2.5:1.0 (or for simplicity, just 2.5).

Here’s what I don’t like about Asset Turnover Ratio:

• It uses “average” total assets. I have never liked using average; I feel “average” is way to make substandard performance look acceptable.
  But more to this case specifically, how do we “average” the total assets in your business? If you just take the total at the beginning and the end of the year and average those two figures, you will get an “average,” but how accurate is it? Should we be measuring assets each month and average 12 measurements? What about assets that are acquired then disposed of very quickly between measurement strike dates? I’m not a fan of average.
• There is no clarity between which value to use when measuring assets (I.E. market value or book value)
• The calculation does not, by definition, include leased assets (leasing has become quite popular.)
• To be truly meaningful we must recognize that each industry has different Asset Turnover Ratios that are considered acceptable; sometimes the differences exist even within a similar space. Consider retailing: online retailers would have significantly lower investment in assets than retailers with brick & mortar store fronts. Online retailers would have significantly stronger ATR accordingly.

Once we clarify how we will approach the Asset Turnover Ratio, and maintain consistency in that approach so as to accurately trend your ATR metric over time, the ATR becomes a strong indicator of your business’ efficiency.

1. Determine how you will value your assets:
   – when will you measure the asset values (frequency, date(s), etc.)
   – eliminate confusion and ambiguity…do two calculations, 1 with market value of assets, and 1 with book value
   – do not exclude assets under a capital lease, it will provide a false positive. Assets under a true “operating lease” can be excluded.
2. Understand how your ATR applies to your industry. If there is a deviation in your results versus industry, is it stronger or weaker; what is causing it?

What I like about Asset Turnover Ratio:

• it creates a stark illustration of how well a business utilizes its assets (which is a MAJOR draw on capital)
• it is a key driver of ROA (Return on Assets – a KEY profitability ratio) and OPM (Operating Profit Margin – a KEY efficiency ratio) both of which need to be monitored closely
• it shows the DOWNSIDE of asset accumulation (which, in the farm space, is a difficult conversation.)

Trending performed over many years by advisors with experience durations that are multiples of my own suggest that grain farms and cow/calf operations have ATR in the range of 0.33 to 0.17. Feedlots and dairies typically range from 1.0 to 0.5. User beware: these measurements are using the classical textbook definition.

Plan for Prosperity

As with any financial ratio, evaluating only one ratio does not tell the whole story. As with any financial analysis, how the numbers are quantified will have a profound effect on the results. This is not permission to ignore these important financial indicators, but more so a call to action to understand how each one affects your business so that you can make the informed decisions that will lead to profitable growth.

Not understanding the factors that affect your business is no excuse to ignore them…especially when they are within your control.

But who has ever heard of “Growth Kills”?

I have written about it in this commentary and spoken about it at industry events: business can grow itself to death.

When a business pursues expansion at a pace that exceeds:

1. Management’s ability to manage the growth,
2. The business’ ability to finance the growth, or
3. The market’s ability to consume the growth…

…we have an entity that has likely grown itself to bankruptcy, or the very brink of bankruptcy.

We’ve all seen it. A couple years of back to back successes, and owners feel invincible! The next thing you know, there is new equipment and buildings being added to the operation, fancy vacations being planned, and new personal expenditures (like houses, RV’s, and vehicles) being made like the lotto has just been won. Everyone who sees this opulence must surely believe that this business is very successful.

If owners (managers) are ill-equipped for the rapid success they’ve enjoyed, there is a likelihood that less-than-ideal decisions will be made in the future. As Marshall Goldsmith titled his bestselling book, What Got Your Here Won’t Get You There. Management has to keep up with the change that sustainable growth requires. This could include new knowledge/strategy/execution in areas like cash management, human resources, marketing, etc. Growth kills when management’s ability is stagnant in the face of growing complexity in business.

As sales grow, there is a need for more investment in the business (Eg. property/plant/equipment; labor; technology, etc.) to support the demand. That investment requires capital. Whether the capital is borrowed or sourced from within the business (usually taken out of working capital) has a major effect on the sustainability of the investment. Growth kills when, without a “home-run” or two, investment is pursued to the point that financing is maxed out and working capital is depleted.

What happens when more product is produced than the market can consume? A shift is made, and what once may have been a specialty item is now offered at a lower and lower price until supply has been consumed (see the “model year blowout” and virtually every car dealership every year.) A business that has enjoyed significant growth may decide to increase production based on past sales growth. Such a decision usually requires investment in the business (see the previous paragraph) and investment in inventory. Whether that inventory is raw material, or finished product remaining unsold, it is tying up working capital. How long can a business hold inventory before it converts that inventory to cash? If working capital is been reduced (see paragraph above) the answer is: not long.
Maybe the business is in a service industry. While there likely isn’t any inventory to have to manage, ramping up capacity (hiring & training staff, acquiring tools & equipment for staff, etc.) requires investment. These investments also carry an overhead expense (salaries & wages, utilities, depreciation, etc.) which becomes harder to pay for when market uptake is satiated. Growth kills when we assume the market will sustain our rapid growth for us.

Plan for Prosperity

What led to the recent success in business? Was it deliberate, planned, and executed…was it intentional growth? We recently discussed the ramifications of unintentional growth. Maybe this article should be titled (Unintentional) Growth Kills, but that probably would not have captured enough attention for you to even read it.

Growth Kills when the growth was unintentional and leads the ownership/management group to ignore the reality that (almost) all industries are cyclical. To say timing is everything does not give credit to important factors like strategy and execution, however an adequate strategy will give consideration to timing (to implement the growth strategy.)

It’s all connected. There is no magic bullet; one thing alone does not make success, and if it does, it’s “luck” and it’s short term because luck isn’t sustainable.

Debt Structure refers to the ratio of current/short term debt to long term debt in your business. This metric provides insight into how you are financing your business’ needs.

Those who know me know that I am consistent in my belief that short term assets should secure short term debt and long term assets should secure long term debt. This is because short term debt (think about your current liabilities) is expected to be paid off with current assets (like cash) whereas long term debt would be paid out with fixed assets (if a lump sum is required versus retiring the debt over time with regular payments.) That premise is Financial Management 101, and while not a hard and fast rule, it is sound guidance.

More to the Debt Structure conversation, we calculate this ratio by dividing Current Liabilities (all payments and payables due in the next 12 months) by Total Liabilities; same for Long Term Liabilities (total debt not yet due within the next 12 months.)  Here is an example:

In this example, there are total liabilities of $5,951,350 (calculated as $2,551,350 in Current Liabilities + $3,400,000 in Long Term Liabilities.) The debt structure is 42.8% short term and 57.2% long term. While this is good to know, the next question is “So what?”

On its own, the debt structure ratio does not carry much weight. The value is found in trending the debt structure ratio. For example, if your short term debt trend is increasing it may be an indication of liquidity challenges in your business.

Ideally, calculating your Debt Structure Ratio will cause you to ask more questions and seek more clarity, such as:

• What types of debt make up my short term liabilities? What are these debts for?
• Are my short term liabilities trending up, down, or remaining fairly steady? Why?
• What is the right ratio of Debt Structure for my business/industry?

With economic indicators preparing us for more volatility than years past, and with interest rate increases on the horizon, it is a good idea to have abundant clarity on your overall debt situation. Understanding your Debt Structure, including how your Debt Structure will affect your business under different economic situations, creates an opportunity to “get your house in order,” so to speak, before things start happening.

Plan for Prosperity

The winds of change are blowing. Are you simply going to lower your sail and wait it out, hoping to survive whatever comes? Or are you preparing to chart new courses so that whatever winds you get you are still able to make progress and move forward?

If you are in business, you have heard about KYC: Know Your Customer. Well this is “KYN: Know Your Numbers™” and we begin with the Debt Ratio.

The Debt Ratio (also known as Debt to Asset Ratio) is a leverage ratio, meaning it is a measurement of the debt your business holds. The calculation is “Total Liabilities divided by Total Assets” and the result of the calculation tells you how much of your assets is financed. For example, if you have $5million in total liabilities and $10million in assets, your Debt Ratio is 0.5 : 1 (or just 0.5 for simplicity.)

Each industry has a “comfort zone” for where a debt ratio should be. This comfort zone is also flexible (to an extent) depending on where you are in your business’ life cycle. Knowing what the comfort zone is for the industry in which you operate is important.

Why I am Cautious About the Debt Ratio

1. Because it lends itself to subjective information. Here is what I mean: when buying something, we want the price to be lower; when selling something, we want the price to be higher. While compiling the value of all your assets (a “selling” mindset) it is easy to value what you have at a premium, because A) it is yours, B) you love it, and C) you want to show that it was a good decision to acquire it.
   If the value of business assets is “padded,” then the calculation presents a skewed result to the positive.
2. Off Balance Sheet Items. Over my 15 years as a lender and business adviser, I couldn’t even count the number of “off balance sheet items” I have had to discover. Whether it be trade credit from a vendor (which would lower the total liabilities), leases and leased equipment (which lowers both the total assets and total liabilities), or “forgotten” accounts payable (which, again, lowers total liabilities), the figures that somehow do not get included in the calculation can lead to a profoundly different result
   If the value of the liabilities is incomplete, then the calculation presents a skewed result to the positive.
3. Appreciation of asset values “support” increasing levels of debt. Assets that have experienced an appreciation in value (such as real estate or quota) will lower the Debt Ratio with all other things being equal. This can provide an false sense of security to then take on more debt because “the debt ratio is strong and improving.” This is especially dangerous when the new debt is short term/operating debt. Should the value of those assets decline, there will quickly be pressure put onto the business by creditors.

These examples are not to suggest that there is malicious intent when providing information to do this ratio, but merely to draw attention to a subconscious behavior that is affected by emotion.

Plan for Prosperity

Knowing your numbers is critical, but only looking at current numbers may not tell you enough. What has been the trend of your debt levels, your assets values, and subsequently your debt to asset ratio? What has led to the changes in your asset values? Was it asset appreciation? Do your assets now include far more depreciating assets than before? What has led to the change in your liabilities? Was it debt paydown, or new long term debt? Was it additional short term debt/operating debt? Are your current liabilities making up a greater portion of your total liabilities than 5 years ago (or 10 years ago?)

In the next KYN commentary, we will discuss the trend of short term liabilities & long term liabilities, and how it affects Debt Structure.

How is your business affected by:

• NAFTA
• Trade Wars
• Real Wars
• Geopolitical strife
• Interest Rates
• Income Tax
• Sales Tax
• Foreign Exchange
• Oil Prices
• Commodity Prices
• Utility Prices
• Inflation
• Deflation
• Theft and Vandalism
• Weather and Natural Disasters
• The 4 D’s (Death, Divorce, Disagreement, Disability)
• Physical, Emotional, Spiritual, and Mental Health

You have full control over none of these. At best, you might have partial influence over two or three on that list. Yet you, your business, and ultimately your family will all feel an effect that falls somewhere between minimal and profound.

The way to minimize the negative effect of any of The Uncontrollables is to prepare. You wouldn’t head out on a road trip with an empty fuel tank and no spare tire, would you?

A strong balance sheet (meaning low Debt to Equity along with surplus Working Capital) will mitigate the negative effects of The Uncontrollables. Conducting sensitivity analyses on the likes of tariffs, interest rate changes, tax changes, and foreign exchange will provide your business with the critical knowledge needed to make informed decisions in the face of The Uncontrollables.

Plan for Prosperity

We can scream and holler, protest, or pout all we like in the face of The Uncontrollables; it will change nothing.

God grant me the serenity to accept the things I cannot change, the courage to change the things I can, and the wisdom to know the difference.

-Reinhold Niebuhr

Having the wisdom to know the difference between between what you can control and what you can’t is merely the fist step; acknowledgement of what you cannot control on its own will not mitigate the effect of The Uncontrollables. Action will trump intention every time.

Take action to protect your business, your family, your legacy. You need not be a rudderless vessel helplessly surviving on the mercy of the sea. There is no need to be stranded on the side of the road with no fuel, no spare tire, and no phone.

“…it (recent economic growth) is driven by another round of financial engineering that converts equity into debt. It sacrifices future growth for present consumption.”

– Steven Pearlstein, June 15, 2018

The comparison was being made to the US housing crash that kicked off the global financial crisis in 2008. We all know what happened there; no need to rehash it here.

Yet here we are, barely 10 years later, standing at what some people feel is the precipice of another recession.

“Those who cannot remember the past are condemned to repeat it.”

– George Santayana (Ref.)

The statement from Pearlstein referenced above does have application locally: the recent rapid appreciation of farmland has provided a financial backstop to farm businesses that would have otherwise found themselves painted into a very tight corner. The present consumption, elevated operation costs and living costs driven by high priced equipment and higher living standards, is what, in this space, is leading to the sacrifice of future growth. Here is what I mean…

Les Henry recently penned an article titled Saskatchewan Farm Income and Land Prices which was published in Grainews. He compares farm income and land prices having converted both to 2018 dollars to quantify his position. An example Henry uses in the article describes how a friend of his purchased a brand new loaded Lincoln in the mid-1070’s and how the equivalent number of bushels of wheat, the staple crop in those days, was approximately 1,500 bushels needed to purchase that car. My dad used to make the same argument using the example of the only new tractor he ever bought: a 1974 CASE 970 that arrived in the yard with the plastic still on the seat. The qualifying statement was that it only required 2,870 bushels of wheat in 1974 to buy it; about 7 bushels per acre on his small farm. What does 7 bushels of wheat get you today on your farm?

Les Henry believes that current land prices are unsustainable. If he is correct, then we are almost certain to experience a bubble, even if it is a small one simply because of the amount of “equity” being used to backstop present consumption. Equity is in quotes because it was not earned equity from retaining profits in a business, but rather windfall equity from land value appreciation (similar to what set off the US housing crisis.) The rise in land values created the equity that, in many cases, has been turned into debt. Should land values pull back, lenders will be quickly re-evaluating their security and making some difficult phone calls where warranted.

If there is a bubble happening here, all that “equity” that was converted to debt has certainly helped create it.

Plan for Prosperity

We have dedicated a lot of space to discussions on growth here recently. It saddens me to think that future growth may have been sacrificed for current consumption. However, unless the wolves are near the door there is still opportunity to right the ship. Profit opportunities can be found, but it will take work, intention, and likely having to answer some uncomfortable questions.

The last five weeks we have discussed business cycles, elasticity of demand, the power of a network, intentionality in your business, and your vision in your business. It is no surprise that each of these topics, if parlayed into tangible action within your business, translate into a stronger entity that would likely provide a view from high on “success mountain” looking from a safe vantage point well above the “precipice of economic recession.”

If you want some ideas on how to climb higher up onto Success Mountain, please call or email.