In the last column, our discussion centered on a producer’s question concerning possible trapdoors in finances over the next few years. We discussed world politics and military action creating extreme and volatile margins. This was followed by the “government will take care of us” mentality and potential knee-jerk reactions by institutions such as the Federal Reserve and lending regulators. Let's move on and discuss more trapdoors.

Preparing for an earnings and asset correction

Economic cycles are a fact of life that is often driven by human behavior. Get ready for an earnings flip. This occurs when costs remain elevated while prices temporarily or permanently decline, creating negative or squeezed margins. This is why a spreadsheet with cost of production and breakeven scenarios is essential.

To avoid the trapdoor, determine whether you have built enough financial cushion to absorb tight margins and losses. This is why the burn rate on working capital reserves can assist in determining a business’ resiliency. A strong green light is when the business has a three-year working capital reserve. For example, if working capital is $300,000 and losses are $100,000, this would equate to a three-year reserve. The trapdoor is wide open when the reserve is less than one year.

The next generation

Whether it is an agriculture producer or an agricultural lender, not having a well-trained next generation that is ready to step up to the plate is a major trapdoor. At a recent agricultural banking school, 77 percent of the participants had less than one year of experience.

A well-trained and relationship-based lender is essential during these volatile economic times. Do they know your industry, business, and your personal and family goals and direction? Interest rates are important, but a return on the relationship and the aforementioned characteristics play a critical role to keep your business from sliding into and down the trapdoor.

On the other hand, does the next generation of producers have the right stuff? Are they trained, competent, responsible, and accountable in finance, marketing, human resources, and business practices? Will the older generation hand off the finances, which are critical in decision-making in each of these areas? Remember, the borrower-lender relationship is a two-way street to work together for business success and to reduce the probability of slipping into the trapdoor.

Source: David Kohl, who is solely responsible for the information provided and is wholly owned by the source. Informa Business Media and all its subsidiaries are not responsible for any of the content contained in this information asset.