Downsizing rarely desirable, but plan can improve outcome

There are farm management challenges that are just plain difficult to work through successfully. The challenges can be complex and involve several areas of management.

One of the most difficult things I do in helping farm families pertains to downsizing.

It is not that difficult on the face of it: give up rented land, sell off part of the breeding herd or even sell some land.

There can be good reasons why downsizing makes sense. Often, it’s a function of a farmer’s age and no opportunity to transition the farm to the next generation.

There are situations where selling assets can make an operation more efficient and result in improved profit generation.

This usually occurs when a farm has outgrown its ability to operate efficiently. In these situations, downsizing can bring a farm back to a size where it can operate with optimum financial efficiency.

However, more often downsizing is forced on a farm because of unpleasant financial realities.

The need to sell assets can be the result of a farm’s financial situation, which has deteriorated over time to a point where working capital and associated cash flow is insufficient and the farm struggles to operate.

In those situations, a cash injection is needed.

In situations where the farm cannot borrow more money, the next place to look for cash is to sell assets such as land, equipment, breeding livestock and quota.

If the assets are productive — that is, directly associated with production — then there is a corresponding reduction in revenue.

The reduction in revenue leads to less available cash, causing the farm to return to the same difficult position from which it started, albeit with fewer assets. It can feel like a vicious circle.

The best outcome from downsizing may come when you can sell an asset upon which there is little or no debt. That way, the maximum available cash is generated by the sale.

The larger the existing debt on the asset that is sold, the greater the amount of the sale that has to be applied to paying down the debt and the less residual cash there is to address the cash flow challenges.

Downsizing can also be triggered when partners or shareholders in a combined farming operation decide to break up the operation and farm independently. Reasons for the breakup can include:

  • partners who come to a mutual agreement to farm independently
  • multi-enterprise farms in which the partners have passion for one of the specific enterprises and perhaps less or no interest in the other enterprise
  • situations where conflict is so entrenched that there is no way the partners can be in business together any longer

Regardless of the reason why the breakup is occurring, it results in the operation being downsized.

There are efficiencies that come from running a larger operation, such as allocating fixed costs over a larger production base and how the business has been capitalized and financed.

These efficiencies disappear with the downsizing, and the result is two farm operating units that are less financially viable as independent units than when they existed as one unit.

A reduction in profit from the downsizing associated with a partner breakup is not great news, but it can potentially be managed.

This becomes particularly difficult is where there is a large amount of debt. Decreased efficiencies result in decreased profit. The decreased profit means less money is available to make principal and interest payments on long-term debt.

Downsizing often results in weaker financial performance.

When a larger operation is broken up, the remaining individual units are less profitable and viable than they were as an intact entity.

However, no matter what the reason is for downsizing, the right planning can improve the outcome.

Determine as accurately as possible what the costs and financial realities will be on the other side of the downsizing before going ahead.

Too often partners push forward — either in anger or with stubbornness — without taking the time to look at how the current situation could perhaps be better managed and, with some planning, arrive at better outcomes.

Terry Betker is a farm management consultant based in Winnipeg. He can be reached at 204-782-8200 or terry.betker@backswath.com.

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