The adage that ‘cash is king’ is still very important for businesses. However, the primary source of cash is a sound operating cash profit—other than the short-term liquidation of working capital or assets there is nowhere else it can come from.
In a previous series of articles I presented overviews of fruit industry sectors based on the available published data. The overall analysis presented a challenging picture and, whilst some growers will be doing well, my understanding is that many fruit businesses are doing it tough and this may continue for a while. Financially, the picture is one of hard-won profitability and higher debt.
The adage that ‘cash is king’ is still very important for businesses. However, the primary source of cash is a sound operating cash profit—other than the short-term liquidation of working capital or assets there is nowhere else it can come from.
How much cash profit is enough?
| Element | My figures ($) | Your figures |
|---|---|---|
| Living expenses | 50,000 | |
| Core debt and equipment repayments | 30,000 | |
| New, annual, orchard reinvestment | 50,000 | |
| Off-farm investment (say, superannuation), if possible | 10,000 | |
| Total cash needs | 140,000 |
In broad terms, sufficient cash profit must be generated each year to cover a number of elements (see Table 1).
Operating cash profit is normally equivalent to net profit plus depreciation. In earning profits, some allowance must be made for tax—so the required operating cash profit to sustain $140,000 of outgoings is likely to be about $186,000, allowing for an average 25% tax rate.
Although bad years are unavoidable, the above outflows tend to occur during most years. So there is a need to achieve that target profit during most years, and good years must recover the ground lost in poor years.
If profits are not sufficient to cover these outflows then, over time, they will be paid by increasing borrowings. The more poor years, the higher the debt climbs until it reaches a point where the bank manager becomes concerned.
The need to DRIVE profit
Although many types of businesses have a cyclical earning pattern, one of the features of an agricultural business is that annual income is generated by one short-term event: the harvest.
Costs are initially sunk into developing a crop, and then you get the result that comes after harvest. There is, perhaps, a sense that we are not in control of operating profit once harvest has occurred.
Real example
I was recently working with a large agricultural business on this very issue.
This business had accumulated substantial debt, and the annual operating profits weren’t covering drawings and capital outflows.
At one meeting the realisation came that it was just not good enough to accept that the operation was hostage to the business cycle.
Despite the nature of farming there was a realisation that ways had to be found to drive profit. There was no other alternative if that business was to consolidate, then reduce, debt.
If this couldn’t be done, the family agreed that assets would be sold and members would have to leave farming.
Having farmed for four generations, this was a big decision, but family members realised there was no alternative, and the frank and realistic discussion of their position enabled them to come together as a business management unit to agree that Plan B—to quit farming—was a viable one if their efforts to continue in business eroded more equity.
Their first option was to work hard at understanding how an acceptable profit could be made from their business; and then start to achieve it.
Discuss, analyse and plan
From time to time, financial articles discuss a major national business which is making losses now, but is planning to make a profit in the future by successfully carrying out a number of strategies.
This article continues next month
For more information, see Tree Fruit Dec 2012
