Management experts say identifying defined future goals makes it easier to work through difficult situations.
The power of having a common goal or shared vision cannot be overstated.
I’ve watched families successfully manage through extremely difficult situations, and a written, common understanding of what they were working toward was a big help.
In the absence of a common understanding, human nature causes people to work toward what they individually think the purpose is or the outcomes should be.
Multiple people each working toward what they think the future should be is, at best, not effective. At worst, it can be harmful — to the business and to personal relationships.
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There can be no guarantees of success or exact recipes for working through difficult situations, but clearly, it helps to have everybody on the same page.
All businesses, including farms, are headed somewhere financially. Past performance is an excellent indicator of what a farm’s financial future will look like.
Farmers make management and ownership decisions all the time about operations, investment and financing. Are these decisions helping move a farm’s financial performance to where it needs to be?
Setting financial targets helps answer these questions by creating context for how the decisions will influence the desired outcome.
Without the targets, it is difficult to assess how various operations, investments and financial scenarios will change financial performance.
Targets can be used as performance measures. For example, you can set a high threshold target and see if it can be reached.
The targets can also be measures to not fall below. For example, you can set a low threshold target and make sure decisions don’t cause performance to fall below it.
Some farms I work with set lower value targets that are in line with their borrowing covenants. Setting targets at these values helps farms know when their decisions may be taking them to financial performance levels that are contrary to what was agreed to in the covenants.
Targets are set individually for each ratio or financial indicator. They should ideally be set for a complete set of ratios or indicators, but you don’t have to have a target for each one.
It’s a good idea to include at least one ratio or indicator from each of the major categories of liquidity, solvency, profitability and financial efficiency.
If I was going to track only six ratios, I would set targets for:
- working capital percentage
- equity
- debt to equity
- debt servicing
- gross margin
- net operating profit margin
Obviously, there are no guaranteed outcomes in farming.
Decisions are made with the best intentions in mind, but situations can occur where the financial results are not good. They can be extremely stressful.
It helps if everyone is as clear as they can be on the potential impact of a decision. Having an agreement in place on what performance should look like, as defined by the targets, can help avoid conflict with farm families that stems from poor financial results.
An agreement requires that people discuss and sign off on the process of establishing targets. Doing this makes it harder to point fingers or apply blame when things go sideways.
It’s human nature to loosen the purse strings and pay less attention to financial management when things are good.
However, the focus on financial management should become a much higher priority in the current environment of narrow margins and their effect on financial results.
Here are some recommendations to follow:
- Manage capital investment. Work to drive as much value as you can from the investments you’ve already made. Think strategically about investments you will make. Will they give you the return you need?
- Monitor your overall debt load. Be conservative and where possible, ensure that new debt is associated with productive assets.
- Focus on operating cost controls. The saying goes, you can’t cut costs fast enough to compensate for falling revenues, but any cost cutting savings will be helpful.
- Manage cash flow.
Producers can manage their cash flow by calculating their average working capital for the past five years. Working capital is the best liquidity indicator.
Farms that became bigger during that period may need to adjust the average to arrive at a reasonable current value.
They should then determine how much additional working capital they think they should have to act as a buffer to the financial pressures they’re experiencing.
Finally, they should adjust their management practises so that they can achieve and maintain the working capital they need.
Producers who aren’t comfortable with financial management should find someone to help them.
