The agriculture economy is in a low-margin era with volatility and uncertainty surrounding every headline and tweet. Negative profits and cash flow, which have led to the reduction of balance sheet equity, have been the norm for many farmers and ranchers. Some producers, either by good fortune or intense management, have generated a profit. This has allowed them to incrementally expand and grow the business. At a recent seminar, a producer asked, “What are some of the traps of growth and expansion?”
First, plan for Murphy's Law. If a construction project is in the expansion plans, overestimate the cost of materials and inputs by at least 25 percent. If additions are being made to existing facilities, 25 to 40 percent cost overruns should be tested in the feasibility analysis.
Time to completion of an expansion project will often result in 25 percent more time than initially expected. Weather, tariffs on supplies, and supply chain management are just a few of the surprises that lurk around every corner. Therefore, testing for disruptions or time-to-market need to be assessed.
Evaluating the time to market is particularly important for value-added businesses.
It often takes a minimum of three years to build a brand. Sales coming in under projections or costs exceeding budgets can be a big strain on cash flows and working capital reserves during growth.
Do you have the horsepower for the expanded size of the operation? Of course, this could mean having the equipment capacity for an expansion, but an overlooked element is management and employee horsepower. In some cases, the business outgrows the business IQ of management.
Be careful of paying for capital expenditures out of cash flow. While it may seem like a good idea, paying for capital expenditures from cash flow resources can hinder working capital lines of credit. While the tax savings incentives put in place by the new tax laws are also a benefit, one must balance these tax savings with cash flow deficiencies.
Finally, having a good agricultural lender is critical. Open communication with lenders is vital. A good agricultural lender can help you to follow the ratios and benchmarks to ensure that debt service is still within the possibilities of payback.
In this high volatility and low-margin era, the keyword is managing expectations. Base hits rather than home runs will be the general rule over the next few years. This needs to be backed up with working capital and equity as a defense strategy because one mistake could cost you up to a decade of profits!
The opinions of Dr. David Kohl are not necessarily those of Corn and Soybean Digest or Farm Progress.
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