Evaluating your Progress
Your financial plan should allow you to set targets and monitor progress through a number of crucial indicators. These include:
Debt to equity ratio
Inventory value and turns
Social and environmental metrics
Measuring the Tangible Impacts of Beneficial Business Practices on Canadian Farms is a report from AMI based on research linking the monitoring of key performance measures to financial success. It is an excellent resource to review the various measures and develop a monitoring system that works for you, as well as to understand why tracking your benchmarks can increase your likelihood of success.
Key topics for financial benchmarks
Any business should track revenues and expenses at least on a monthly basis. If an expense is unexpectedly getting out of hand and reducing or eliminating your profit, it is best to know as soon as possible. For instance, many Canadian businesses rely on imports of raw ingredients for value-added products or inputs for farm businesses, and deal with constant fluctuations in currency. This can create volatility in the cost of goods which should be constantly monitored. Even if you are not dealing with currency conversions, it may affect the cost of your inputs, as well as the success of other businesses you rely on. If you are exporting, it affects your revenues, as well as the cost of transportation across borders.
2. Net profit
Along with profit margins, this number is a useful check on the progress of the business. However, it is not enough alone, as other aspects of your financial picture have a larger impact than others, and it is important to keep an eye on these as well as on the bottom line. Some of these are discussed below, as well as in the linked resources.
3. Debt to equity
The higher the debt to equity ratio, the higher the risk in a business. Lenders and investors will review this and other similar metrics to determine the credit worthiness of your business. A good rule of thumb is to design the financials not to exceed 40% debt financing. A 60% equity level lets lenders and investors know that the owners are committed and engaged with the project. Commercial lenders are generally not willing to be the lenders of first choice. They want to know that if there is other debt, it will be subordinated to the debt financing they offer. “Subordinated debt” means that in the case of problems in paying back loans, the banks or credit unions will be paid first; other loans (member loans, bonds, etc.) will be subordinated to the commercial debt.
The principle of maintaining a reasonable debt percentage is based on a shorthand way of checking that the debt can be repaid. A high debt capitalization means that you may have to be counting on a rapid and unlikely increase in profits at the beginning to be able to service the debt. Businesses have however managed higher debt levels through the use of patient capital (with long terms for pay back and/ or low interest rates)
4. Inventory value and turns
Inventory represents an asset that is often an unstable asset in the food sector. You might have twelve tons of apples in storage, but if they sell slowly and you end up throwing half of them into the compost, then you have only really had six tons in inventory and are paying to store the rest without a revenue return. Likewise, in the case of cider or some other value-added product, it is not making money sitting in the warehouse. This creates a challenge for many farmers to balance storage as a hedge against low prices, vs. the danger of shrink (inventory loss) and the cost of the storage. Many distributors as well as retail stores have moved towards “just-in-time” inventory, which means that they bring in product only when it is sold, and do not hold any in storage on speculation of selling it. Packers may bring product in to store, but often only pay on “pack-out”, processing it once the product is sold. This allows the packer to package to specifications, sorting apples into the size asked for by the customer, bagging carrots by weights based on customer needs. For the producer it means waiting until product is sold and deteriorated product discarded before receiving payment based on sales. Some commodity markets feature various forms of contract and futures options that make this balancing act even more complicated. Processors may also use processing planning and scheduling to respond to market fluctuations, benefiting from small batch processing to customize product to market demands. For instance, dairy processors estimate the amount of eggnog need each winter holiday season, knowing that the demand may be large but very short-term. A smaller processor faces less risk in such a case, because they can do smaller batches to match the market as it rises and falls.
An advantage of processing at an appropriate scale for small to mid-scale farms is flexibility and the ability to do small batch processing. This facilitates testing the market for a product, and producing small amounts for niche markets, with larger amounts for more conventional markets. From the point of view of field production schedules, there is less flexibility. For example, even if the price has plummeted on tomatoes, they must be harvested in a fairly narrow window of time, and then can only be stored for a short time, often not long enough for the prices to recover.
Tracking the inventory value can help a producer and processor decide in diversified market channels and production types. An apple grower that found they were losing too much on storing apples, as well as being forced to ship at lower rates in order to move them before they decompose, might add a line of dehydrated apples, cider, or other products that could be sold outside the fresh apple market, increase revenues, and increase sales in the months when the fresh apples are gone.
Inventory turns is the number that represents the number of times in the year or month that the value of the inventory is replaced. It can be calculated by taking the cost of goods sold in one period and dividing by the average cost of the goods in inventory.
If Juice and Jams sold $600,000 worth of jam, and the cost of goods for that revenue was $400,000, and the average inventory over that year was $50,000, then inventory turns were 600,000 divided by 50,000, or 12. This tells you the inventory of the Juice and Jams company was, on average, fully sold and replenished once per month over the twelve month period. Each sector has different standards for appropriate inventory turns. A micro-greens business would have very frequent turns, with product going from seed to harvest very quickly. A potato business might have slow turns because of the option to store after harvest for root vegetables. If you are not storing anything, or are able to produce to sales, the inventory turns number would not be important. However, product in storage is an important factor in finances that sometimes is ignored.
5. Labour costs
Labour tends to represent a high percentage of the costs of a business. It is a complex consideration, because high quality labour and long-term job tenure can save you money in reduced errors and minimal training time. It can look like a higher percentage on the books than the experts recommend, yet there is a hidden pay-off in the efficiency of your business. It is common for business experts to recommend staff reductions when a business is struggling, but injudicious staff eliminations can reduce your sales and fail to solve the problem. Labour is usually monitored as a percentage of gross sales, and the correct percentage depends on the type of business. Businesses often aim for 9-11%, although co-operatives historically have succeeded with higher percentages.
6. Loss, waste and redirection
Another important number to track is loss; this is also frequently ignored, and can make the difference between success and failure. Standard rates vary by sector. Distributors relying on just-in-time inventory may have little shrink, while retail stores may have as high as 10% shrink in some categories due to consumer unwillingness to buy imperfect product. Organizations like the Provision Coalition have begun to work with food corporations to reduce and redirect waste, in some cases turning a waste stream into a revenue stream. The waste stream in some cases is redirected back into the input stream as in the case of a closed loop carrot washing system, or the Cowbell Brewery in Blyth, Ontario. The rise and fall of the loss number should be carefully tracked; in all cases, it represents something that has a cost of production with no corresponding revenue and can create havoc with your bottom line.
7. Social and environmental measures
You may have identified additional measures in the previous module that you want to track. For social benchmarks you might have set targets in job creation, quality of workplace, staff benefits, education. For environmental benchmarks you may want targets in waste, utility usage, packaging. These metrics are likely to be interconnected. If you offer high quality jobs or staff training, this may offer benefits in revenue as well as a decent workplace. If you redirect or reuse waste, it will reduce the cost of disposal in one case, or input costs in the other. Realistic budgeting should include the interconnection of metrics. If you complete the new system that redirects waste heat from the chicken barn into keeping the warehouse warm, what are the savings in heating costs? How long would it take for the savings to pay for the cost of installing the system?