Applying what you've learned from your business management plan.
(The first in a series discussing common challenges and opportunities that arise when analyzing your monthly profit and loss statement.)
Over the past year, our series on business management has put us in a position to begin making some prudent business changes. Wth your roadmap in place, you're now ready to test drive your business plan.
The next five articles will examine challenges that may be affecting your bottom line and look at ways to turn those challenges into opportunities. Each individual article will state a challenge, then describe some of the operational management adjustments made to attack the challenge.
As you read through these articles, bear in mind that the management changes suggested or implemented may or may not fit your operation, your environment, or your special set of circumstances.
Interest Expense Is Usually #1 Of all production expenses I often find interest costs as the most out of line on a production unit basis (i.e., exposed female, animal weaned, pounds of beef weaned). It's often the most clear-cut to reduce, too, but can be the most difficult decision to make because it can involve the sale of assets such as cattle, equipment and/or land.
Interest expense is dead money. Certainly you have to have money to make money, but a high interest expense in a low margin business like agriculture is very detrimental to the long-term viability of the operation.
In a cow-calf agribusiness it's difficult to justify more than $50/exposed female in interest expense. Bob Campbell of Farm Credit Services in Rapid City, SD, says his rule of thumb is that the agribusiness interest expense cannot exceed 10% of gross revenues.
But what if your agribusiness has an interest expense which exceeds these profitability guidelines? What do you do?
Look At Liquid Assets First, take a look at your liquid assets, primarily cattle and equipment. These assets could be sold with the proceeds used to pay down debt. Be sure to discuss capital gains tax considerations with your tax advisor. Don't let the fear of paying taxes interfere with a decision to sell an asset, especially if it's the best management decision for long-term profitability of the business.
One ranch I work with had an interest expense of $87.50/ exposed female. It was a 750-head cow-calf operation, which was tapped out on stocking rate. In fact, it was so heavily stocked that the ranch had to hay very marginal ground and even a bar ditch or two just to get enough hay for the winter.
In this case, the first thing we did was scale back the cow herd. We sold 250 cows, based on individual calf and cow performance, age and functional efficiency. You may say the same thing the rancher said when I suggested this, "I'm trying to make more money. How can I do that with fewer cows?" Sit back and watch!
We also decided to send the remaining 500 head to corn stalks for the winter at 27.5 cents/head/day (less feed and hay). In addition, we made the decision to delay the subsequent breeding season by two weeks to allow us to keep cows on corn stalks longer (less feed and hay). The feed saving alone more than offset the lighter weaning weights.
By reducing cow numbers we reduced feed and hay requirements. No marginal ground or bar ditches would be hayed. In fact, we were able to evaluate and eliminate a portion of the haying equipment which now became excess. Equipment sale proceeds were also applied to debt reduction.
With 250 fewer cows and a greatly reduced feeding period, the ranch had an opportunity to take in custom cattle on excess pasture and marginal hay ground. We took in 750 yearlings from a feedlot at $25/cwt. cost of gain. We estimated gain at 1.5 lbs./day and billed the feedlot on a monthly basis. This created nearly $8,500/month worth of positive cash flow. This "off season" cash flow reduced the amount of operating note needed, since we weren't just waiting for the fall weaned calf crop for cash flow, again reducing interest expense.
A number of other minor changes were implemented, such as selling all old equipment and scrap metal. Although the minor changes didn't add up to much, every bit helps, especially in a business as tough as agriculture. Even if it's just 50 cents/ exposed female, would you rather that 50 cents be placed in your pocket or in your banker's pocket?
All in all, interest expense was reduced from $87.50/exposed female down to a projected amount of just $7.78/exposed female in FY 1998.
Other Options On another operation we had to sell a small piece (500 acres) of aesthetically pleasing property located on a ranch lake. The property was priced at four times pasture value with the conditions of the sale that the parcel could not be fenced from the remaining pasture and a 99-year grazing lease would be granted to the rancher. Cost of the grazing lease, normally $125-150/cow-calf unit, was then exchanged for the right to hunt the remaining 1,600 acres in that pasture.
Following payment of capital gains tax, all remaining proceeds were applied to debt reduction. Ultimately, the total interest expense for this ranch was reduced by over $17,000. In addition, the producer was still able to graze and manage the property without a cash cost to the agribusiness.
On yet another operation, we're in the process of selling young running age cows to investors to pay down debt. The ranch then leases the cows back from the investor at a set price and also provides the investor with a buy back clause at the end of the seven-year depreciation period. The herd size is maintained through replacement heifer retention. At the end of the seven-year period the ranch buys back a similar-aged herd with improved genetics and production efficiency. This type of approach will not work as well if you're not in a value-added situation and/or placing strict production criteria to the herd.
There are many other approaches, which will be discussed in subsequent articles. Operational efficiency systems implemented to attack a totally different ch allenge, however, also have a positive affect on interest expense. Few changes in operational management have an affect on only one expense category.
In a number of cases we've been able to negotiate a more favorable interest rate on operating loans as a result of having a concise Integrated Business Management Plan (IBMP), which details how challenges are to be attacked and opportunities are to be capitalized on.
Your agribusiness is a much lower risk and more favorable loan than those without a plan. Therefore, if your bank won't give you a more favorable rate, you might consider taking your plan and your business elsewhere.
The bottom line of interest expense, with few exceptions, is that it must be kept under $50/exposed female and/or 10% of gross revenue to maintain profitability on a long-term basis.
Additionally, do not overlook the liquidation of any and or all of your assets to preserve the business. We must not get caught up in emotional attachment to liquid assets such as favorite cows or a tractor, and cause the total collapse of the entire agribusiness.
Next month we'll discuss the challenge of feed expense, often the highest cost category in Northern operations and higher than it should be in Southern climates.
Tom Hogan co-owns and operates AGRI-PLAN Corp., an operational efficiency and financial management consulting firm. For more information or his 100+ page manual, "Planning Your Way to Profit," which guides you through the strategic planning process, call him at 800/793-1671 or e-mail: AGRIPLAN@compuserve.com