Taking growth opportunities is usually the more straightforward choice. A decision to consolidate requires greater discipline, especially when it means resisting the temptation to move towards new horizons.
There are various reasons consolidation may be the best choice. Industry statistics confirm many farms have excessive debt, much of it resulting from land purchases at previously inflated values and the accumulated impact of deficits driven by drought or trading volatility after the global financial crisis.
These buoyant times offer a chance for businesses to improve their equity levels. Achieving stronger balance requires patience and commitment but the reward will be a more robust foundation from which to springboard when the next growth opportunity occurs.
My attitude to businesses with excessive debt is that they need either to ‘grow into it, or get out of it’. The need is to select a strategy to ‘right size’ the business.
Ignoring the need for consolidation and pursuing continued growth invites into an operation what I regard as ‘business cancer’: it increases business risk through greater pressure on people, cashflows and vulnerability to climatic and economic volatility.
When this occurs some operators develop a ‘live in hope’ mentality. Rather than setting clear targets to drive towards debt reduction, they can be inclined to focus solely on physical performance and hope market prices or economic conditions will rescue them. This relatively hands-off style of management can result in the business simply going from crisis to crisis.
So what some response strategies?
First, work on a sustainable capital structure through clearly defined rates of debt repayment. Discussions with bankers and professionals will enable calculation of optimum debt levels based on long-term ‘steady state’ budgets. This will in turn determine the required level of profitability so physical performance and cost structures for the operation can be quantified.
Second, get into the habit of repaying debt. Wherever a surplus occurs it should be committed to debt reduction before it is consumed with new equipment, personal spending or other discretionary choices. The business’s reputation and the credibility of its owners will be enhanced by this approach. Conversely, ambivalence and lack of discipline will undermine confidence, especially of bankers. Actions speak louder than words.
Debt reduction strategies could include securing the favourable interest rates that have been available in recent years. Committing the savings in servicing costs to additional principal repayments can be a way to accelerate debt reduction.
Finally, when managing excess debt, the focus should be on the excess debt rather than the total debt. Failure to acknowledge this often results in borrowers wrestling with the burden of their total exposure and banks increasing interest rates and penalising the business as higher margins are applied to the total debt. My view is that lenders could give much clearer signals about where the real challenges lie if they primarily focus on penalising the excess debt.
The 2014 season to date, in most locations, has kept on on giving. The grass has grown exceptionally well and so far milk prices are moving in the right direction. This combination offers a classic opportunity to capture surpluses for consolidation that will create equity structures to ensure profits are the norm not the exception.
• Kerry Ryan is a Tauranga agribusiness consultant available for face-to-face or online for advice and ideas. www.kerryryan.co.nz
