UnCommon Farms is entering its fifth decade of service to the North American farmer. Throughout this near half-century of service, the focus has been to help producers access, understand and apply the insights hidden in their financial records. Our premier offering and most effective tool in pursuit of this goal throughout our long history has been the Historical Performance Analysis report (HPA).
Why a Historical Performance Analysis is Crucial
While the HPA is a historical analysis tool first, it is really designed to help ag businesses think about their futures. It has been said that math is the best crystal ball mankind was given. In other words, the historical trends exhibited by a business, when extrapolated into the future, are the best indicator of future performance – they forecast your future successes, challenges, and opportunities.
An HPA starts with five (5) years of financial results. This includes both income statement and balance sheet information. Fifty-four (54) numbers are actually all that is needed to paint a clear picture of where your business has been, how healthy it is, and where it is likely to go. The specifics of these 54 numbers are identified later in this article, but the key thing to note now is that 54 is a relatively attainable goal. Without getting overwhelmed in detail, these numbers give a comprehensive picture of the business. There are always opportunities to go deeper into the details, but if a business owner is struggling to understand the financial health and performance trends of his or her enterprise at the comprehensive level, then exploding into more data points will only deepen the confusion. The HPA serves the purpose of providing key management perspectives and feedback without overwhelming detail and obfuscating complexity.
Your Balance Sheet and Income Statement are Key
As mentioned above the HPA draws information from two sources: your income statement and your balance sheet. Producers vary in their degree of financial record keeping sophistication. This does not matter as the information required for an accurate Historical Performance Analysis can be sourced equally well from GAAP accounting audited records as it can from a tax return. In terms of profit and loss (income statement), the need is for information that matches production expenses with the revenue generated from the production activity that incurred the expense. Because of the long production cycles in agriculture (often spanning three calendar years), some adjustments to the source data are made.
However, even with cash basis data, the five-year nature of the HPA minimizes the distortion that simply the timing of cash flows presents to management. In addition to the attempt to push expenses into the appropriate production year and to pull revenues back into the appropriate production year, the HPA data requirements seek to separate true operational costs from financing activities. For this reason, interest expense, depreciation expense, dividends, and taxes are all represented separately. Here dividends include all owner compensation – an analytical approach that fits the reality of closely-held, owner-operator-type businesses.
The balance sheet, a statement of financial health, maintains a cumulative (running-total) of the business’s activity and results. The key consideration here is that Asset valuations be at market. Fair market valuation of assets on the balance sheet gives management a lot of invaluable information, which is actually different than what is required for tax purposes. Especially with regard to land and grain inventory, unrealistic valuation of assets can distort everyone’s perception of business reality – which serves no one. Additionally, assets used in production are often sitting in different legal entities. These entities must be consolidated (or at least combined in some way) to get an accurate picture of the business with proper elimination of transactions and/or accounts that overlap between the entities. Now with consolidated and properly adjusted data, analysis can begin.
The Sections of Your HPA
Five sections comprise the HPA, and each provides management insight into the risks and opportunities the business faces as management steers it into the future.
Operations Management
The first of these sections focuses on Operations Management. This section provides feedback about trends, volatility, adequacy, and performance against the standard. However, Operating Profit Percent is the key measure here. Its trend can forecast real competitive weakness looming for the business. Its performance against standard can let management know if too much strain will be pushed off on lenders, owners, and/or existing equity. For example, a five-year average Operating Profit Percent below 24% and with a downward trend is a clear indicator that the business needs to curb spending and take control of operations.
Capital Management
In the Capital Management section of the analysis, management can gain a clear perspective on trends and appropriate levels of funding (in and out) to owners, lenders, the business itself, and interest costs (interest is essentially a payment to people that have invested in your business.) If an area is consuming more than their fair share, another area will be underfunded, and the business will suffer. Competitive reality says that the vast majority of producers have well over half of operating profit available to plow back into their business year-over-year. While having it available is not the same as spending it wisely, it is a required first step. Another key disclosure in this section is the cumulative investment made into the business of funds from all sources. The stewardship exhibited by management with these funds is a strong indicator of future success. The investment should show up as increased revenue, greater efficiency, deeper liquidity, or at least expanded equity. If it does not, there is clear need for reflection.
Liquidity
Liquidity is a measure of cash assets (plus assets that could quickly be converted to cash) versus near-term liabilities that claim those assets and will demand payment. Liquidity is the shock absorber of the business and production agriculture certainly drives a bumpy road. Fortunately for many in this industry, there is a robust lending business happy to lend against the farmer’s most prized asset – the growing crop. Wise producers maintain their own liquidity and minimize the amount of access they give lenders to their most prized asset. The Liquidity section of the analysis gives three strong measures of performance in this regard.
Equity, Ownership, and Asset Performance
The final two sections of the report provide the deepest scan of the business’s performance. This is where key trends in equity, ownership, and asset performance are assessed. This is a muddied area for producers as several of their assets (land in particular) have both a productive purpose and an investment purpose. By beginning to tease these two different objectives apart, management can begin to think strategically about their asset procurement decisions – to think differently about the project they undertake and the major asset purchase they make. Equity can slip away quietly if it is not being watched. By monitoring the metrics presented in these sections, management can see trends that allow them to address latencies that would otherwise threaten solvency and control.
Knowledge is not the same as action. It is, however, a precursor to appropriate action. Not that chance and other heuristically conceived action plans are always wrong – especially in the face of an uncertain future – but better decisions with a higher likelihood of success (as you define it for your operation) will align with businesses that take the time to assemble, understand, reflect, and act on meaningful and comprehensive information. The HPA provides such information, and it does so in a way that (for those that have learned to read it) fits on a single piece of paper. UnCommon Farms has been using the HPA concepts and calculations since the 1970’s. They have proven timeless and true through our benchmarking of hundreds of businesses. The HPA benchmarks against the standard, but as we shall see in the next discussion, it also offers business managers the benefits and insights that come from benchmarking against a robust group of competitive peers.
Benchmarking
Benchmarking has had its turn as the darling of the business press and the hot topic solution to all the woes a business faces. Thank goodness the days of it being oversold have passed. Benchmarking provides a set of insights and perspectives to management teams that take the time to provide accurate information of sufficient detail. They also allow you to get through learning curves of the key metrics’ meanings and their calculations, and help you own emotional reactions to challenging and exposing information. Lastly, benchmarking also helps you actively seek disconfirming information, and shows you the implications of things so you can formulate action plans to implement. Benchmarking is a window of insight to those qualified to use it, a mirror of denial to those seeking affirmation, and an opaque barrier to those ill-equipped.
Help Through Your Benchmarking Journey
UnCommon Farms has been providing benchmarking opportunities, supporting industry standards initiatives, and leveraging technology to collect and manage data for well over 40 years. We understand the challenges that each stage of the process contains. Whether collecting, presenting or applying benchmark information, there are unique costs and benefits that everyone involved in the effort should fully appreciate if the value is to be realized. This article describes the costs and benefits of each of these three areas from the perspective of the Historical Performance Analysis (HPA) data collected from our customers.
Computer technology holds great promise for speed and efficiency in collecting data. This is important for benchmarking’s value proposition. Remember, the value is best understood as real and perceived benefits divided by real and perceived costs. This means that there are two ways to improve the value of the effort: reduce cost and increase benefits. Both of these strategies are (and should be) pursued. The cost of assembling data for a benchmark is directly related to the availability of that input data. For financial benchmarking this means that the business has up-to-date financial records that are accurate, that comply with standard, and are of sufficient detail.
For many producers, getting to the point where such records exist is part of the process. UnCommon Farms helps by offering a staged-in approach, by coordinating meetings that serve as training and networking sessions, and by providing support personnel to assist in the process. A producer can start in a meaningful and valuable benchmarking relationship at the first stage if they can provide just 10 key numbers per year. These numbers are entered on a secure web page and are stored in a secure database so that the full capability of modern reporting solutions are available.
UnCommon Farms has worked hard to improve the benchmark reporting process and its corresponding analysis as well. Using SMED (single minute exchange of dies) principles, borrowed from manufacturing, UnCommon Farms has reduced the time between entering data and receiving a deck of benchmark reports to less than one minute. Being so dynamic also means that corrections are instantly processed – updating all reports. Ideally, everyone has plenty of time and perfect accuracy, but pragmatism is the better approach.
Thus, a participant can move quickly to get started with benchmark analysis, learning the concepts and seeing results. For the HPA Financial Benchmark that we have been discussing, this means that the management team can consider what-if scenarios and probe the magnitude of observed shortfalls (for example, to raise Current Ratio to the target value are we looking at a $100,000 problem or a $750,000 problem?). From that, UnCommon Farms can help you forecast and benchmark future sentiments. Benchmarking adds a new dimension when it is focused on the future instead of the past. Financial benchmarking at the overall level is important as it lets the management team know exactly where they stand competitively. UnCommon Farms can help your business - explore our agricultural accounting and consulting services.
