Klinefelter: By the Numbers

Boost Your Odds of Business Failure - 1

Too many operators rely on cash-basis accounting and other lax controls that only alert them to financial problems after a crisis occurs. (Photo by Coolcaesar, CCA-SA)

As he often does, Virginia Tech economist Dave Kohl recently wrote encouraging me with another column idea. This time he prodded me to write not about the attributes of successful farmers but about worst management practices. Particularly now with volatile returns and narrow margins, farmers don't have the luxury of being behind the curve and still getting satisfactory results.

There are an endless number of options, but I've picked 21 things that too many farmers have been doing that need to change. Because the list is long, we'll tackle the top 10 here, and finish the remainder in part 2 of my monthly DTN column later this week. Here are tend of the 21 practices I hope you'll avoid.

1. Using cash-basis net income and changes in market value net worth to assess business performance. It has been known for decades that cash-basis net income can lag accrual adjusted net income by 2-3 years in identifying changes in true profitability. Cash is great for tax management, but terrible for measuring actual profitability. There are too many strategies that can be used to manage cash-basis net income; inventory management is a prime example. Because timing is the key differentiator between the top 5% and the rest of the top 25%, the lag in identifying problems or capitalizing on opportunities is just too great. The same is true for using changes in market-value net worth, a lagging indicator, rather than changes in earned net worth to evaluate the quality of business management.

2. Practicing poor communication. This includes within the business and between those in the business and those not in the business but with a vested interest. Peter Drucker said 60% of all management problems are communication problems. Too many farmers keep things other people need to know to themselves. Family business consultant Don Jonovic always said most farms aren't just closely held, they are hermetically sealed. Employees and family members need to know: what they are expected to do and how; why they are doing it; how they are doing; how they can improve; where the business is headed (vision); how does it plan to get there; what is their role; and what's in it for them. Also, family members need to know the CEO's estate plan and plans for succession.

3. Being too independent. Success in the future is going to depend more on recognizing and capitalizing on interdependent relationships. Those can include collaborative farming; trading or jointly owning assets; employing specialized expertise; becoming a qualified supplier in a coordinated supply chain; or pooling purchases, etc. I tell my Extension cliental in Texas all the time that their extreme independence is both their greatest strength and their greatest weakness.

4. Not knowing your strengths and weaknesses. Most people have only a vague clue how well they stack up against the abilities of their competitors. Being successful doesn't mean being good at everything. It's about knowing and compensating for weaknesses and capitalizing on your strengths. Often this requires delegation, outsourcing or forming an alliance with someone who complements you.

5. Not setting priorities and then prioritizing the priorities. Many of the most important things never get done because people tend to do what they like to do, what's easiest and quickest to get done or what is urgent. That crowds out doing what is most important to continuously improve business performance. This is usually because most producers haven't set priorities or because they aren't willing to delegate.

6. Spending to avoid taxes. This isn't always a bad thing, but the first thing needs to be analyzing the marginal contribution of the investment versus the marginal cost of the investment over time and the impact on liquidity.

7. Not benchmarking against the leading edge of your competition. This isn't just financial, but also best management practices. It has to be based on comparable data and information. Again this is learning what your weaknesses are and what you need to emphasize or do differently to keep improving your performance.

8. Not writing down your assumptions and the basis for them. Memory is limited and selective. If things change and you need to alter your plans, you need to know what you were thinking when you originally developed the plan. Do you need better or additional information the next time around? What have you learned from the experience so you can do better the next time you develop a plan.

9. Paying family members at levels not supported by the value of their job. If you want them to have a better standard of living, they need more responsibility or you need to be gifting to make it clear it's not for the value of what they're doing. It obviously makes sense from a tax deductibility standpoint but it sends them the wrong message as well as to the rest of the team. Pay should reflect the market for the job, responsibilities and performance. Otherwise it's a disguised form of charity or a welfare subsidy.

10. Investing in non-productive assets or excessive family living costs. These have been the downfall of too many operations. Living below your means is one of the primary findings discovered in a 20-year study published in the book, "The Millionaire Next Door." There is a tendency to raise the standard of living to unsustainable levels during boom periods and to buy too many non-productive "toys" as Dave Kohl likes to call them. Then operators assume the acquisitions are necessities when economic downturns occur. Personal spending is also among the biggest cost differences between high performing and low performing businesses discovered in numerous studies of farm records data.

For the remaining farm business practices that assure failure, watch for Part 2 of this column later this week on DTN.

EDITOR'S NOTE: Danny Klinefelter is an agricultural finance professor and economist with Texas AgriLIFE Extension and Texas A&M University. He also is the founder of the mid-career Texas A&M management course for executive farmers called TEPAP. Paid subscribers can access all of his DTN columns online using the News Search feature under News.