Planning your budget for next year is a tough task for many growers, but there are a few tricks to keeping on top of your books. When it comes to planning, there are some financial metrics nursery and greenhouse growers need to know.
Scott Mickey, extension associate for agribusiness at the Clemson University Cooperative Extension Service, provides two important formulas growers should use when budgeting for next year.
Neither of these formulas are industry-specific and both apply to nursery and greenhouse growers especially when tracked year after year.
The first financial ratio growers should know:
Working Capital (Current Assets – Current Liabilities) / Operating Expenses (all expenses except Interest & Depreciation)
That formula provides your working capital efficiency, which is a measure of the liquidity of the business.
“The reason I like that one is it gives me an idea going into the year of how much of my expected operating expenses I can cover with the working capital I have at the end of the year,” Mickey said.
Ideally, your business should aim for 25% or more. That's a solid goal, Mickey said.
“So if you want to spend $1,000,000 in operating expenses, you need to have working capital of $250,000 at the beginning of the year,” he said.
How to calculate it
Your current assets are items that are going to turn to cash within one year.
Normally when you look at your balance sheet, they're going to be listed this way: the items at the top are already cash. Items at the very bottom of your balance sheet aren't expected to turn to cash for a long time.
Items that are considered assets: cash, your accounts receivable, inventory. Also, any prepaid expenses on the crop.
Inventory that will be for sale in the next year is also considered an asset.
“However, if I’m taking a plant from a 1-gallon pot to a 3-gallon to a 5-gallon and it’s going to be a 7-gallon plant when I sell it, it’s not really a current asset,” Mickey cautioned. “It’s going to be a long-term asset. If you know that 3-gallon plant is available for sale, you could put it in your current assets. Maybe you pot 100 of them figuring you’re going to sell 75 and repot and size up 25.”
Comparing this year against last year is a valuable benchmark, but it loses its utility if your books are done a different way. Make sure you are treating the same items as current and future assets from year-to-year. Consistency is key.
“The biggest caution I would have here is just be consistent year-to-year with how you’re treating that inventory,” Mickey said.
Current liabilities are items that need to be paid in one year. That includes accounts payable, accrued interest on any outstanding debt. Depending on the business’ structure, it could include income taxes. It wouldn’t be on the balance sheet for sole proprietors, but it could be payroll taxes or accrued interest on any outstanding debt. The big one, Mickey said, is the current portion of principal on long-term liabilities.
For instance, if a nursery owner bought a loader for $50,000 and financed it for five years, he or she would only have to come up with the current portion of the principal this year. In this case, if he’s paying off $50,000 over five years, his current portion of the principal would be $10,000. The other $40,000 is considered a long-term liability.
The second part of that equation is operating expenses. That includes everything a company spends except interest and depreciation. It includes labor, rent and input costs like growing media and fertilizer.
So if a business expects to have $1 million in operating expenses, it would take its working capital divided by 1 million. The resulting number is the working capital efficiency.
When evaluating a business based on its working capital efficiency, Mickey uses a 3-level system: vulnerable, resilient and agile.
“Agile is kind of a green light area that is over 25%,” Mickey said. “Your business would be vulnerable if it’s under 10%. So if you have less than 10% working capital expenses as you enter the year, you’re probably going to have liquidity issues.”
Liquidity is important for growers for many reasons.
"You've got other needs for cash in the business during the year besides operations,” Mickey said. “You've got loan principal on term debt payments that need to come out of this working capital also. So if you only have 10% you don't have much cushion for anything else. You've just got to use everything. That means you're going to be borrowing on operating lines or increasing accounts payable pretty rapidly as you go through the year."
Some growers on the greenhouse side may think they can get by with less liquidity because they turn their crops so often. Mickey cautioned that even though they’re getting paid more frequently, they’re also spending money more frequently. It’s still important to try to improve your liquidity if you’re in that vulnerable position.
If you have accurate financial records, try to assess your working capital efficiency over a 3-5 year history. For instance, if you’re at 10% now and you were at 5% 3 years ago, you’re making progress. For growers with liquidity issues, that’s a huge step in the right direction.
“I feel better about that than a grower that started at 25 three years ago and now is at 20,” Mickey said.
“He's still in a better position, but his trend is not what we like to see. You don't need to get in a panic if you find you're at 10%. You just need to have a plan for moving that.”
EBITDA Efficiency (EBITDA – Earnings Before Interest Taxes Depreciation and Amortization) / Gross Revenue
This second formula is useful for growers because it helps them determine if they’ve got too much debt for the earnings of their business.
Basically, you take your total revenue and subtract all your expenses except the interest, depreciation and amortization. That’s your EBITDA, or shortened to just “earnings.”
Ideally, earnings will be 30% of revenue remaining after you pay all your expenses. So if a grower had revenue of $1 million, to be considered agile, its earnings would be $300,000. That’s not profit, because you would still have to subtract interest and depreciation. What it can be thought of is a hard number that shows how much is available for equity growth and debt service from every dollar generated.
In this example of the grower with $1 million revenue and $300,000 earnings, Mickey said ideally you would not want to spend more than half of your earnings on interest and principal payments. And he would not spend more than 25% on income tax. That would leave 25% of earnings to go toward asset acquisition, whether it’s buying a piece of equipment or just putting cash in the bank.
“That’s where it gets fun, if you can manage your debt and get it down and increase your equity quicker with the same 30% EBITDA efficiency,” Mickey said.
Mike Gooder, president and CEO of Plantpeddler in Cresco, Iowa, believes growers should take a closer look at their finances, especially their costs.
“We are pretty hardcore into cost analysis," Gooder said. "And I think, if there's any recommendation I have for growers, it's the fact that this the time you can look at your costs and be relatively safe in raising prices no matter what markets you serve because there's an expectation. As people have inflationary costs impacting almost everything in their lives, they have an expectation that the $4, 4.5-inch geranium is now going to be $4.50. If your cost of goods, cost of labor and cost of energy are going up, those are the three biggest costs in the greenhouse. If you're not raising prices now, there may not be a tomorrow.”
Make sure when you're putting those formulas to work that you account for input costs. As most growers know, they've been skyrocketing. Darrell Bunnell of Coview Farm and Greenhouses in Coberg, Kentucky, said the variable cost has made pricing a difficult but crucial proposition.
"We had to raise prices last year because the cost of everything went up so dramatically," Bunnell said. "The plastic pots, the soil, everything went up. So we went up on some things and stayed the same on some other things. We don't like to increase everything right across the board. Pricing is going to be big. You don't know what the prices of things are actually going to be until they get them in.”