In today’s agriculture industry with larger businesses having more zeros and commas on the balance sheet, income statement, and cash flow, “speed kills” is an appropriate phrase. You cannot wait until year-end to monitor financial performance because conditions can shift so rapidly. Monitoring should be an ongoing process so one can make tweaks and adjustments to avoid getting into the proverbial financial ditch. Speaking of deteriorating financials, what are some of the signs of a business progressing in the wrong direction?
Dave’s Double Dip of Death
No, this is not the latest popular ice cream flavor! It is when the debt to asset ratio exceeds 50 percent and the operating expense to revenue ratio (excluding interest and depreciation expenses) is greater than 80 percent. Corporate entities that take a management draw and producers with large amounts of rented ground could increase the operating expense to revenue ratio threshold to 85 percent. It is recommended that you use at least a three-year trend analysis with accrual adjusted numbers when evaluating your situation. Producers in this situation have high amounts of debt with low margins to service the debt. In some cases, producers could use a non-farm income source or have longer term debt structures to circumvent these conditions.
The next deteriorating financial condition includes the following progression:
- The debt to asset ratio is above 50 percent,
- The operating expense to revenue ratio (excluding interest and depreciation) is above 80 percent, and
- Government payments comprise more than 50 percent of net income.
In this situation, producers have high debt and low margins with a reliance on the government for a positive ledger. This is not conducive for long term financial sustainability.
The quadruple canyon occurs when conditions are in dire straits, and I am not referring to the singing group! The first three conditions concerning debt levels, margin compression, and a reliance on government payments are exhibited. In addition, when the business owners and managers complete the business IQ assessment, which has been discussed in previous columns, the average score is less than 30. In this situation, the owners and managers lack the business and financial IQ needed to proactively turn around the business in this deep financial canyon. The success of the business may be against all odds.
This past year, government stimulus and high grain prices have lifted profits to right the financial ship. However, what is your plan post-government payments when commodity prices moderate and high input costs persist to keep your business out of these conditions?
Source: Dr. David Kohl, which 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.