June 19, 2018
You are a producer and you want to raise your business game, any advice? Given the current, turbulent economic times on the horizon, a high priority for many producers is to increase their financial acumen. I often encourage producers to enroll in courses or attend seminars with a specific emphasis in finance.
Understanding how to develop projected cash flows that incorporate your production, marketing, cost of inputs, and financial plan is critical in raising the bar. Increased volatility and uncertainty regarding trade agreements, tariffs, weather, and interest rates requires producers to be astute and develop spreadsheet skills to test for sensitivity. These are all very critical variables to the bottom line.
Developing cash flows can go a long way to establishing a baseline cost of production. This baseline can be a very important element in planning and executing an effective marketing plan. Extreme volatility will create short windows of opportunity where producers can lock in a profit and be proactive to the business’ specific needs.
Being able to read your balance sheet and understand what the numbers are telling you is analogous to a basketball coach examining shooting percentages, turnovers, rebounds, and assists. Raising your game requires a good understanding of working capital and the relative “quickness to cash” of current assets in order to meet short-term expenses and financial obligations. Working capital is a measure of liquidity calculated by subtracting current liabilities from current assets. A strong amount of working capital allows flexibility in marketing plans and positions the business to handle adversity and capitalize on growth opportunities.
The business game is about knowing proper debt levels. This can be measured by the debt to asset ratio and term debt divided by EBITDA. The debt to asset ratio is calculated by dividing total liabilities by total assets and indicates the percentage of total assets that are financed by creditors. When the debt to asset ratio exceeds 50 percent, a strong management plan is necessary to counter the increased debt service requirements. EBITDA stands for earnings before interest, taxes, depreciation, and amortization are deducted. When the term debt to EBITDA ratio is greater than 6:1, this also indicates the need for higher management and financial acumen.
Yes, my team and I are financially biased. However, history has proven that the producers who are strong financial managers can work side by side with their lenders and tend to be on the positive side of the scorecard when it is all said and done.
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