September 29, 2020
In a recent article our discussion centered on lessons to pass the volatility test. Now, let's move on to passing the business agility test. The economic and financial volatility in extremes is going to be a fact of life for the decade of the 2020s, so having an agile business that adapts to changing conditions is critical.
A key element in passing the test of business agility is the top half of the balance sheet. Working capital and the ability to generate financially liquid assets without disrupting normal operations will be a priority. A lesson learned during the COVID-19 pandemic is that disruptive events can tax a business’ financial liquidity. For example, the shutdown of ethanol plants and processing facilities being rendered inoperable due to employee sickness resulted in producers drawing on working capital reserves to meet financial obligations.
A major test for an agricultural business is to examine working capital in an operational format. While the current ratio has historically been the go-to metric, a new favorite is working capital divided by expenses. A ratio above 25 percent or a quarter of the expenses covered by working capital would be considered strong. Working capital divided by expenses of less than 10 percent, while not fatal, would place the business in a less agile position. When calculating the ratio, one must determine if the financial liquidity was driven by earnings or the sale of capital assets. Working capital could also be funded by lenders through a refinance or restructure of debt. A debt restructure often entails converting short-term operating loans into long-term debt with a 10 to 20-year amortization using land equity as security. Most business analysts would agree that profits and earnings would be the preferred method to obtain working capital.
Next, what is the marketing and risk management program to mitigate the downside risk and lock-in windows of profit? Of course, marketing is often linked to the cash flow statement with the timing of revenues, expenses, and debt service needs. Marketing and risk management programs are often tied to liquidity and working capital, which provide the flexibility and agility needed to pursue different options for profitability or minimizing losses.
Finally, when passing the test of agility, one has to consider the trade-offs and the balance between efficiency versus optimization and specialization versus diversification. This can be done through various enterprises or revenue sources both inside and outside of agriculture.
Many lessons have been learned during the economic environment created by the COVID-19 pandemic. The importance of working capital, a sound marketing and risk management program, and some level of diversification as a method to generate revenue are prime business strategies to maintain agility for both adversity and opportunity.
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.
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