Business growth versus risk
How do I balance business growth with risk? This question, which has perplexed producers over the decades, came from a young producer in the Midwest at a lender sponsored young farmer conference.
First, start with a simple goal setting exercise. How does growth fit with the short and long-term goals of the business and your personal endeavors? In this exercise, identify your top three priorities for both short and long-term goals.
Next, an in-depth evaluation of how growth will affect the business should be completed. How will growth align with your land, machinery, equipment, labor, and management resources? Will an expansion lower your cost of production by spreading fixed costs over more production units? Will growth require additional investments in new resources such as equipment, machinery, and/or labor? How will growth impact your ability to manage the business? Will you be stressed to the point of attempting to juggle too many responsibilities? Can you delegate responsibilities? Will you be able to attract and retain qualified, productive workers?
If the business is in a growth mode, the adequacy of working capital must be evaluated. Working capital is a measure of liquidity, calculated using current assets minus current liabilities. Will growth drain your working capital? Before expansion, the ratio of working capital to expenses should be 30 percent or greater to provide flexibility in case of macroeconomic issues or possible trade disruptions. Post expansion, this metric must be 10 to 15 percent of expenses. It is also recommended that 25 percent of your working capital consists of cash or other assets that can quickly be liquidated or converted to cash. Murphy’s Law will often raise its ugly head during an expansion, which is why extra financial resources are necessary.
Next, examine your debt levels. What is the impact of growth on your debt to asset ratio? Once this ratio exceeds 50 percent, you are in a riskier position. With high financial leverage, working capital to expenses post expansion should exceed 25 percent. A good crop and livestock insurance program will also be necessary to mitigate risk.
Another ratio I examine when looking at growth is term debt to EBITDA; this ratio is calculated using total term debt divided by EBITDA. EBITDA stands for the amount of earnings before interest, taxes, depreciation, and amortization are deducted. If this ratio exceeds 6:1 in your post growth plans, then the growth may be placing your business in a risky position if micro or macroeconomic issues arise. A good working relationship with your lender will be imperative to help guide you through the financial obligations that growth requires.
Remember, growth will generally place butterflies in your stomach and may give you an uncomfortable feeling. However, growing your operation is an important part of the business life cycle which can be fulfilling as a business owner. We have discussed only the tip of the iceberg in addressing how to simultaneously achieve business growth while managing risk; most importantly, it takes careful planning and preparation.