This book does not begin with land planning, stock density, paddocks, and grazing periods. It begins with financial planning, because money is the ruler. For better or worse, it is the ruler, even though your holisticgoal goes far beyond profit. In fact, both the materialist who finds the breath of life in crisp green paper and the poet who would rather live without it might find more peace of mind and freedom of spirit by accepting the notion that money is nothing but a tool. It is certainly not fulfillment and not necessarily even wealth, broadly speaking.
Holistic thinking would be infinitely harder without the benefit of a tool like money with which to measure progress, though, of course, money is certainly not the only measurement. By definition, holism deals with “wholes,” in which many elements affect each other simultaneously, but the human brain can’t handle everything at once. Since your wallet probably can’t, either, Holistic Financial Planning is the process through which you will reduce the grand notion of holism to the practical matter of what you do first and how much of it you do, so the whole will come out right.
The very words “financial planning” may remind you uncomfortably of income tax time. As with tax preparation, it is not filling out the form but gathering the information to fill the blanks that presents the greatest challenge. Unlike the result of tax work, however, the result of financial planning is prosperity and dreams come true.
At the information-gathering stage you will begin to formulate a general strategy based on your analysis of your situation and your “holisticgoal.” The framework for Holistic Management comes into its own at this point. The holisticgoal and testing guidelines will help you keep a perspective on when to use money as the yardstick, when not to, and how to decide priorities.
Holistic Financial Planning is the single most important activity you can undertake each year to ensure that all the money you earn and spend is in line with your holisticgoal. If you seek prosperity and financial security, few activities during the year count more than this planning. It takes precedence over vacations, interruptions, and excuses of any kind.
As explained in the Holistic Management text, the whole thing depends on having a holisticgoal that ties what you value most in life to your life support system. Your holisticgoal starts with the quality of life you are seeking, states the forms of production that will help you achieve it, and then describes the future resource base that will ensure both are sustained. As a practical matter, you cannot proceed through the planning process without keeping this trinity clearly in mind at all times. Ambiguity about your holisticgoal may not result in an unworkable plan, but it could very well generate a plan you won’t want to work (and may even sabotage subconsciously).
Your holisticgoal should invite creative thinking, not limit it. A duck-hunting rancher may automatically list “profit from livestock” or “migratory water bird habitat” as forms of production. However, more general categories such as “profit from land-based enterprises” or “abundant wildlife” will help keep your mind open to possibilities outside those that you and your neighbors already know. A narrowly defined form of production such as “profit from winter wheat” kills imagination and flexibility. Further on in the planning you may indeed test the profitability of any number of specific land-based enterprises, perhaps including livestock and wheat. Or you might explore the feasibility of reconstituting an old irrigation project as a wetland. At the level of your holisticgoal, leave all options open.
Don’t forget that a future landscape description is a critical part of your holisticgoal. You can’t make long-term progress in terms of production and quality of life if you don’t take steps to produce and maintain that landscape.
As money is merely a measurement, so profit is a means to reach other aspects of your holisticgoal, particularly those related to quality of life. A close family, the creation or preservation of good land, public service, church work, the education of your children, loyalty to relatives, and many other desires and duties all put demands on profit. If you do not have these things in mind when you plan your commitment of money and labor, you will make a plan that you will inevitably scrap the minute these other aspects of your holisticgoal demand it.
Clarity in your holisticgoal will enable you to avoid temptations and opportunities of tremendous promise that nevertheless lead in the wrong direction—for you.
“My neighbor is selling out. I could get a great deal on his hay machinery. Why not get it?”
“The government has a cost-share program. Should I participate?”
“My husband just won a trip for two to Fiji. Should we go?”
The procedures in this chapter will help you organize a huge amount of complex information about operations that go on simultaneously, but you still have to go one step at a time and put one thing ahead of another. Clarity in your holisticgoal and a deep commitment to achieving it make that possible.
At this point reread the textbook chapters 25 through 32 on the testing guidelines: Cause and Effect, Weak Link, Marginal Reaction, Gross Profit Analysis, Energy/Money Source and Use, Sustainability, and Society and Culture. A brief summary also appears in appendix 1.A. In the Holistic Financial Planning process, all your policies and projects must come up for review through these guidelines as you allocate resources. You may start from a thousand ideas, but before you actually plan action on any of them, you have to evaluate their soundness and set priorities. What enterprises, what investments in land improvements, what training for your staff, and so forth, will you try to carry out with the resources you have? Use the testing guidelines when you do this. They cut about 90 percent of the confusion out of this task, but unfortunately they don’t eliminate it all.
Remember, when testing any decision, you must be clear about what it is you are testing. Don’t rush to test a decision before you’ve clarified what your objective is—to reduce weeds in a pasture, buy a tractor, or whatever—and discussed all the aspects you normally would: what you know or need to know about the proposed action in terms of past experience, research results, a friend’s advice, expert opinion, or what it will cost. Only then should you check through the testing guidelines to make sure that in achieving your objective you also move closer to your holisticgoal.
Speed is essential to the testing process, or you risk losing sight of the whole. However, two tests, Cause and Effect and Gross Profit Analysis, require a lot of thought and, in the latter case, calculations using pencil and paper. Do them first if you are dealing with a problem (cause and effect) or comparing enterprises (gross profit analysis). Then pass quickly through all the other tests that apply.
As neat as the testing guidelines appear in theory, they overlap a good deal, and for good reason: What you might miss in one you pick up in another. Sometimes it proves impossible to figure out where one or another applies, but of the seven a few will almost always prove critical in a given case. Some, such as sustainability, almost always apply. Don’t agonize over ambiguity in regard to any one guideline. They all function together like the elements in one of those filters that purifies water through a series of screens, flotations, and catalysts, each of which eliminates one class of contaminants while ignoring the rest.
It’s important to remember why you are doing what you are doing, so let’s recap. You have a holisticgoal you are working toward that is guiding all your decision making. You are attempting to make decisions that take you toward your holisticgoal in the most economically, socially, and environmentally sound way, both short and long term. The testing guidelines help you do that. They come into play in Holistic Financial Planning because in deciding where to allocate money, you are actually making most of the major decisions for the year.
In conventional planning, managers first plan production—crops, meat, timber, hunting leases, and so on. Then they calculate the anticipated income for the year, then the expenses, and finally cut and paste until they see a positive balance. This tends to make profitability the ultimate test, for which all other considerations are compromised.
Holistic Financial Planning proceeds in a rather different way. Profit itself is a form of production that ranks alongside other elements that will sustain your definition of a good quality of life, which probably includes prosperity or at least economic security.
You might qualify profit as “profit from crops” or “profit from hunting,” and you would describe a future resource base and landscape that ensure that you can produce it for years to come. Then you test all the actions you take to achieve that profit to ensure that they are socially, environmentally, and economically sound—simultaneously—both short and long term. These tests include a “gross profit analysis,” which is designed to highlight how much each enterprise contributes to covering fixed costs, or overhead. This ensures that a plan will indeed produce profit.
When you plan production and then test profitability, you tend to overlook or skimp on details that cost you profit, and in the end very likely produce undesirable social or environmental consequences.
On the other hand, when you plan a profit and then test all the activities you engage in to achieve it, you are more likely to earn substantially higher profits and less likely to cause social or environmental harm further down the road.
The textbook covers cause and effect, sustainability, and society and culture well enough to warrant no further practical advice here. The same goes for weak links in the social and biological contexts. The other tests, however, require some translation into dollars and cents. Let’s take them one by one.
The Financial Weak Link guideline has profound implications for deciding the fundamental question of planning: “How do I maximize the income I can generate?”
In training sessions the weak link guideline is sometimes introduced like this:
Instructor: “If I kept adding tension to this chain, where would it break?”
Class: “At the weakest link.”
Instructor: “And if I strengthened that, where would it break?”
Class: “At the next weakest link.”
Instructor: “No, at the weakest link.”
It’s a teacher’s trick to focus on the fact that at any given moment there is only one weakest link, and you must deal with it before considering any other link.
You are trying to build an operation and an environment (future resource base) that will endure, so you and following generations can sustain a profit. To do that, you want to ensure every year that your major investments of money and labor keep strengthening the weak link in the chain of production that exists at any point in time for each of the enterprises you engage in. Once you have identified the year’s weak link in each enterprise, you look at all the actions you could take that would strengthen that particular weak link as soon as possible. When allocating money for expenses, those actions that address the weak link in an enterprise will receive priority, assuming that other tests have been passed and the action is clearly leading toward the holisticgoal. Expenditures that address a weak link are considered wealth generating because they boost production, and thus profit, to a new level, though perhaps not until the following year. Other expenditures generally maintain production at current levels.
The chain of production always has three links, as shown in figure 1.1. If you are a rancher or farmer, your primary production is based on the conversion of sunlight energy (through plants) to a salable or consumable product, such as food, fiber, lumber, wildlife, or recreation. Jargon aside, this means that plants capture solar energy to make food, then you turn that “food” into a marketable product—bale of hay, gallon of milk, bird watching opportunities, hunting or fishing lease, or whatever. But you have to actually market that product or service before you have a dollar in your hand that you can live on or reinvest in the business. Ideally, you want the money you invest in a weak link to be in the form of solar dollars, which ranchers and farmers produce through harvesting sunlight and converting that sunlight to money, as long as soils aren’t damaged in the process. Mineral dollars achieved at the expense of lost soil or paper dollars borrowed from the bank can be used to strengthen a weak link, but in the first case they could undermine your future resource base, and in the second they usually come with interest attached.
The key to generating wealth is not in the things you sell, but in how you reinvest the money earned.
Although the weak link in each enterprise shifts from year to year and can shift within the year, Holistic Management training programs put great emphasis on the resource conversion link because ranchers and farmers have a tendency to leave that one to God, who unfortunately has seldom interceded to mitigate the effects of human neglect. The discovery of the four insights that are key to understanding our ecosystem, however, passes the buck back to human management. You probably can produce a better range that will turn more sunlight into edible carbohydrates and protein or farm in a way that builds soil fertility and reduces vulnerability to drought.
Figure 1.1. Human creativity first needs to utilize raw resources—sunlight in particular—and money to create a product or service. Then the product or service needs to be perfected and finally marketed to produce money. The chain is only as strong as its weakest link.
Each enterprise you manage will always have a weak link at any moment in time. Thus, if you run cattle and sheep and plant sorghum, winter wheat, and Bermuda onions, you’ll have a weak link to find in five different enterprises. Whatever you determine to be a weak link, you must set in motion an action plan to strengthen it. This action plan will show up on your financial planning sheets as a separate expense column for training, fencing, advertising, or whatever strengthens that link in the chain.
Even though purchasing feed allows you to carry more animals, it does not strengthen the resource conversion link in terms of harvesting more sunlight. Fencing, land acquisition, plantings, or improved drainage, however, could. If you have too few animals to consume the forage you produce, then product conversion is the weak link, and a plan for increasing animal numbers addresses that link.
If the resource conversion link is weak for the hay enterprise, an investment in a new swather or engine overhaul would be a waste of money. A new drainage system makes more sense because it enhances growth and thus solar energy conversion. Therefore, if your equipment will last another year, put the money into tile pipe instead.
There is often a gray area between the product and marketing conversion links. For example, poor-quality wool might be considered a product conversion weak link if it was tied to the quality of the animals that produced it but a marketing conversion weak link if it was delivered dirty. What matters in these cases is not the precise positioning but that you see the problem and address it as you reinvest in the business.
You may have enterprises that are not directly dependent on solar energy conversion, as is the case with most urban businesses. A bed and breakfast enterprise on a corner of the property would be such an example. In this case the resource conversion link does not involve the conversion of sunlight. The resources you’re converting to a product are money and creativity and might include building materials and the retired couple from town who will run the operation.
Money derived from the mineral wealth of the earth we term mineral (or petrochemical) dollars, and money derived through plants grown by the power of the sun we term solar dollars. A characteristic of mineral dollars is that we can choose either to use the resource from which they are produced over and over in a cyclical manner, or to mine and consume the resource all at once. Soil would be an example. We could choose to build soil and continue to use it for centuries, or we could destroy and erode it until it is gone. Tragically, mainstream agriculture has chosen the second option in most instances.
Solar dollars are produced directly or indirectly from plants. As plants, like humans, are totally dependent upon soil, a farmer is not strictly producing solar dollars unless soil life, and thus soil, is maintained or enhanced.
The third form of money, paper dollars is based upon human creativity and financial transactions, and its basis is no deeper or more solid than the public’s confidence in the economy and the government. This form of money is very unstable and can be created or destroyed as land values, interest rates, stock prices, inflation, and currency exchange rates fluctuate.
Here are some things to look for when trying to determine the weak link in the chain of production in a given year:
Livestock Operation
Resource (Sunlight Energy) Conversion:
• Forage shortfall
• Paddocks too few, or herd control too poor, to minimize overgrazing
• Too many herds
• Drainage poor
• Plant species composition poor
• Low litter accumulation
• High supplement cost
• Inadequate or unbalanced soil fertility
Product Conversion:
• Unutilized forage that is oxidizing
• Sufficient forage but
– low calving/lambing rate
– poor gains
– poor genetics
– high mortality
Marketing:
• Low prices
• Market resistance due to
• insensitivity to demand
• inadequate research
• poor quality
• poor sales effort
• ignorance of market mechanisms (futures, etc.)
Crop Farming
Resource (Sunlight Energy) Conversion:
• Acreage too small
• Inputs too high (fertilizer, etc.)
• Poor water cycle management
– drainage poor
– overirrigation
• Planting only one crop when two or more crops could be grown in a field in the same year
• Planting too late
• Monoculture cropping
• Poor germination
• Poor crop health
• Inadequate or unbalanced soil fertility
Product Conversion:
• High damage loss (insects, disease)
• Low-tonnage marketable product versus dry matter produced
• High harvest and handling loss
• Excessive crop-drying costs
• Transport damage
Marketing:
• Low prices
• Market resistance due to
– insensitivity to demand
– inadequate research
– poor quality
– poor packaging
– poor sales effort
– ignorance of market mechanisms (futures, etc.)
– unnecessary middlemen
Ranchers or farmers are better off measuring their success in solar dollars only and relying on the paper ones at their peril. The argument is both moral and practical. The health and fortune of humankind cannot be sustained without the creation of solar dollars, and those engaged in the management of natural resources accept a special responsibility in this regard. On the practical side, the more you can rely on solar dollars, the more you insulate yourself from swings in land and commodity prices, interest rates, and the like. This does not mean ignoring such matters. In fact, it demands a particularly nimble and flexible attitude toward them. All borrowing, especially if it is based on the current real estate market, involves paper dollars to some extent, so obviously your position is more stable if you can finance your plans out of solar dollars generated by your operation.
The second aspect of this guideline asks whether the planned use of energy or money is consumptive or cyclical. Is the use good only once, or is it durable in that it builds infrastructure for future wealth? As the wording of the guideline—Energy/Money Source and Use—indicates, you must apply the test to the source of energy and money that you use and to the use of the energy and money that you generate, and you must consider both aspects within the context of your holisticgoal. For example, the use of diesel fuel in clearing land represents a consumptive use of a nonrenewable energy resource produced elsewhere. However, done once to produce a new cropland it could be in line with your holisticgoal, as it is building the infrastructure needed. The use of fossil fuel to aerially spray weeds infesting your rangeland would constitute an addictive use of that resource unless you had first removed the cause of the weed infestation. Clear-cutting timber to make a loan payment is a consumptive use of solar wealth if it destroys the productivity of the soil. Better forestry practices or conversion into sustainable pasture might pass this test.
It is particularly helpful to apply this testing guideline as you weigh ideas for strengthening the weak link in the chain of production. Of dozens of ways to proceed, some will represent a better use of energy and money than others. At the product conversion level, many rationalize heavy grain feeding to push livestock to a higher market class. Though the cash return may appear too good to refuse, the feed typically represents a consumptive use of soil and fossil energy. Finding a different market might reduce the need or even eliminate it altogether.
To some degree the Marginal Reaction guideline is the accountant’s equivalent of the weak link test, but it applies in many nonquantifiable situations as well. If you followed the guideline perfectly, you would make your investments one dollar or one hour at a time, asking for each, “Where will this move me the farthest toward my holisticgoal?” Each dollar (or hour) goes where it will yield most, and this changes whenever diminishing returns on one investment drop below what the next dollar or hour might return somewhere else. The textbook illustrates this process by a clear example using dollars and percentages. The only pitfall in practice is an expectation that you can quantify every situation. You can’t. Since your holisticgoal can’t be quantified, you will have to compare apples and oranges.
Assuming that two or more different actions would help strengthen a particular weak link, there is little or no possibility that both or all of those actions would provide the same return toward your holisticgoal for each additional dollar or human hour invested. Since you are addressing a weak link and every dollar matters, you use this test to determine, to the best of your ability, which of the alternatives gets all the dollars you can assign to it this year. Most commonly, you will be looking at marginal reaction per dollar or human hour of effort. However, if some other resource was limited, you could at times compare marginal reaction per unit of that limited resource.
Suppose resource conversion is your weak link. You can buy land, lease land, develop water on land not now accessible, reseed old land, hire herders or build fence, or retrain your staff. Which will have the greatest marginal reaction?
Advertising may strengthen a weak marketing link if you have to establish a market. After a point, however, extra publicity has only a short-term effect. Then storage facilities to gain market flexibility or better breeding stock to improve quality might have greater marginal reaction. They might enable you to enter new markets and stop wearing yourself out holding your share of a limited one.
Debt, Overhead, Risk, and Scale
The key to survival in a world dominated by paper dollars is remaining flexible—being able to change enterprises and not feel helplessly locked into selling commodities, or continuing as Dad did. In no industry is this truer than agriculture, where markets, weather, land prices, and input costs constantly fluctuate. The two graphs illustrate how costs (fixed and variable) and scale of production relate to each other. If you study them long enough to fix them in your mind, they’ll help you think through any number of investment decisions.
Cases I and II show two ways to approach the same enterprise. In Case I the fixed costs are twice as high as in Case II, but the variable costs are half as much, as indicated by a variable costs line half as steep (1/5 dollar per unit against 2/5 dollar per unit). The argument for Case I runs thus: “Invest in this machine (breed, land, irrigation system, fence), and your cost of production will go down, and you’ll realize a bigger profit.” As you can see from the graphs, however, this argument becomes true only when production passes ten units. At anything less, Case II does better. If this “equality point” represents a fairly optimistic level of production, the Case I producer suffers a lot of stress when fate deals him just an average run of cards. He has to pay the high ante and bet heavily just to stay in the game.
The pressure becomes even greater if the fixed costs reflect investments secured by paper values such as land appraisals, which typically also lose value when general conditions are bad. On top of that, risk exposure, as represented by the “loss” area on the two graphs, is vastly greater for Case I and its predictable-as-death high costs.
Case I
Case II
The two graphs in fact give Case I the benefit of the doubt because they do show a trade-off of lower variable costs for higher fixed (capital) costs. If the Case II operator could find a way to reduce the slope of his variable costs line to equal that of Case I, he would, of course, enjoy higher profit at all levels of production, and less risk exposure as well—a nice trick if you can do it.
In practice, many additions to fixed costs do reduce variable costs. But they almost always raise the threshold of profitable production, increase risk, and cut flexibility. Before you borrow and invest, compute that higher threshold carefully and reflect a while on what it means for your finances, your peace of mind, your workload, and your general quality of life.
If you can cut the slope of your variable costs line without adding fixed costs, do that first. Thus management improvements that allow you to increase stocking rates or reduce supplements or labor give you more flexibility than assuming mortgage payments on additional land. When you do compare capital investments—such as expanding through land purchase or fencing to improve your stocking rate—be sure to compute the precise effect on the slope of that variable costs line.
Whether a small family farm can stay in the game turns on the balance of fixed and variable expenses and scale of production, and the deck is sometimes stacked. The most significant economies of scale in agriculture exist in the supporting industries—machinery, chemicals, processing, and advertising—not on the farm itself. John Deere profits most by making a big volume of very big combines. Cargill profits from handling grain by the trainload. Since, ultimately, their money comes from your solar dollars, they’d like to persuade or force you to fit their pattern.
The producer can win by holding on to solar dollars through creative marketing and keeping production flexible. You can plant a new crop much easier than John Deere can open a new production line. If getting bigger means debt and inflexible capital investments, it will force you to play by rules written by multinational, high-volume industries, and they will win at your expense.
Perhaps none of these strategies generates an acceptable marginal reaction in relation to the quality of life expressed in your holisticgoal. More carrying capacity or better sales might increase your income, but your daughter needs a loan to buy the place next door. Maybe that will pay back more in joy than the same money ever could in beef.
The matter is further complicated by the old truth that time is money (and often much more than money). You must consider the marginal reaction of time. Will the hour spent riding fence return more toward the fulfillment of your holisticgoal than the hour spent planning? How about spending the same hour with your family?
Think marginal reaction. You are building a life and a landscape and sources of wealth that will sustain you as far down the road as you dare look. You have to figure how far down that road each dollar or hour will send you.
Simply stated, gross profit analysis is a technique that separates fixed costs (defined here as costs you have regardless of what or how much you produce) from the costs directly linked to production. It enables you to compare many enterprises or combinations of enterprises. Besides expenses normally termed “overhead,” fixed costs can include other expenses that have already been incurred. For example, fertilizer—normally thought of as a variable cost—can be fixed if already bought and you’re making a new decision about crops.
This approach, developed by David Wallace, an English agricultural economist, respects the fact that at any point many costs such as living expenses, debt payments, and full-time labor exist no matter what you produce. So they should not be considered in judging the potential of an enterprise you undertake tomorrow.
Many people do not make this distinction when analyzing the sources of profit and loss. They look only at the bottom line—which tells them little or nothing about which elements of an operation contribute most to covering their fixed costs and ultimately whether those fixed costs are justified. Even when different enterprises in an operation are analyzed separately, it’s common to apportion some fixed costs among them. But that obscures the real contribution of that enterprise toward covering the total fixed costs of the business. People unused to this concept often find the distinction between fixed and variable expenses confusing and want a list. Again, any expense that you can’t avoid in the planning period regardless of what you plan is a fixed expense. Any expense that derives from your plan is variable.
Failure to see the difference can lead to disastrous decisions. The two graphs shown in figure 1.2, for example, illustrate the large-scale ruin of dairy operations in the mountains of western North Carolina. Beginning in the 1960s, industry experts encouraged local dairymen to build continuous milking parlors in association with feedlots supplied by intensive crop production or purchased feed. In theory this would produce more profit per cow—and virtually no end to the number of cows you could have.
Gross Profit Analysis of Fed Versus Pastured Dairy Cattle
Figure 1.2. The left-hand columns compare profits when fixed land costs are allocated according to the amount of land used. The right-hand columns compare gross profit when land costs, which have to be paid anyway, are left out.
The left-hand graph shows how traditional accounting justified this strategy. Cost per cow is enormous, but so is production, so gross profit per animal looks good enough to justify the large capital investment in the new equipment and feed purchase or production. Everything “cash flows.” The centuries-old practice of grazing cows on steep mountain pastures looks pretty poor in comparison.
At the time of the decision, however, all investments in the continuous milking scheme were variable costs. These included such obviously variable costs as feed, vet bills, and semen to produce high-production cows. The cost of the new facilities also counted and should have been calculated as part of the annual cost per cow over the life of the facilities.
The most significant fixed costs were mortgage payments on land, and taxes, which were high because booming second-home development had inflated values. Since only a fraction of the mountain land was suitable for crops and feedlots, little of this mortgage or tax cost was assigned to the intensive milking systems, even though it had to be paid. Meanwhile, huge areas of pasture, laboriously cleared in past decades, went out of production under the new system and in that nonbrittle environment quickly succeeded to forest. There was no going back. Those who could sell land to developers survived financially, but the dairy herds disappeared.
Gross profit analysis would have revealed the problem before the fatal step, as the second graph shows. If variable costs alone are considered, it becomes obvious that each cow on the old mountain grass went much farther toward covering the cost of the land and incurred relatively little “per head” expense compared to the cow on feed. Even when the high taxes ate up profit, die-hard farmers could often supplement their income enough to hold on to their property because the whole farm produced. Gross profit per acre remained healthy, and other inputs were low. The story might have turned out quite differently on flat, fertile land. But in that case a gross profit analysis might well have led to truck farming instead of intensive feed crops and Holsteins.
Gross profit analysis tends to influence your planning in some key ways:
1. You can be far more nimble in response to paper dollar changes. You will know when buying land makes sense, when sheep will do better than cattle, when yearlings beat calves, when to grow hay and when to buy it.
2. You will make much better use of the land, equipment, and labor you already have. The common practice masks the expense of idle assets. Gross profit analysis shows when you’re better off making smarter use of what you have than making “cost-effective” new investments.
3. It makes you extremely aware of fixed costs. In the long run, none of those costs is really fixed. You can sell the ranch or farm itself if you have to. Short of that, you can bias your planning to cut fixed costs and get rid of inefficient assets. Thus you can cut your exposure to the dangers of paper dollars—and compound interest—the great trap of agriculture in the United States and those countries following America’s lead.
The following simplified version of a real situation illustrates the technique for comparing enterprises using a gross profit analysis. The numbers are in South African rand, not dollars, and the relationship between income and animal numbers does not transfer, either, so don’t expect the conclusions to relate to your operation. The method, however, will. In this particular case, two brothers differed as radically as Cain and Abel on the subject of sheep versus registered (or pedigree) cattle. The analysis answered their pressing economic question but not, alas, the human one.
The income and expense account shown in figure 1.3 has had a lot of detail boiled out of it, but it still includes many items that do not figure in the gross profit analysis. These represent items that either have nothing to do with the enterprises in question or are not “variable,” in the sense that you will not get rid of them in the near future regardless of your conclusions about the various enterprises. Note that the analysis side has some categories such as pasture, silage, and hay that do not rate a line on the traditional account but are derived from several of the expense headings.
To compare the livestock options effectively, gross profit analysis results must be reduced to some common and comparable base—dollars per head per year, dollars per acre or hectare per year, dollars per standard animal unit per year, dollars returned per dollar invested per year, and so forth.
In this case, we are given
1,500 sheep
400 commercial cattle
150 registered cattle
The gross profit per head (in rand) would be
If the stocking rate reflects the commonly used ratio of five sheep to one cow unit, then the difference in gross profit per unit of land is drastic indeed. Sheep return R1,705.95 (R341.19 × 5) per animal unit in this particular case; registered cows lose R353.40.
Gross profit analysis helps greatly in determining which enterprises to engage in and also in monitoring the performance of each enterprise. However, all the actions and technologies involved in an enterprise should also be tested. Use gross profit analysis for three purposes:
1. to compare enterprises, as in the example;
2. to see how different conditions such as price changes might affect your enterprise;
3. to weigh the effect of diverting assets from one enterprise to another.
Gross Profit Analysis—Comparing Enterprises
Figure 1.3. End-of-year comparison of enterprises based on actual income and expenses. There are 1,500 sheep, 400 commercial cattle, and 150 registered cattle. In the shaded area, portions of the figures in the first column have been allocated to one or more enterprises because those amounts are considered a direct cost of that enterprise.
Comparing Scenarios
Gross profit analysis can be used to assess the impact of future events or policies. In the example shown in figure 1.4, “poor,” “average,” and “good” refer to price only. You could use the same method to find out instantly how changes in supplemental feed prices, labor policy, weaning percentages, average gain, and other factors would affect your gross profit.
Gross Profit Analysis—Comparing Scenarios Based on Price
Figure 1.4. Gross profit analysis prior to committing to an enterprise. This example looks at gross profit per 100 cows using poor, average, and good prices for sales and replacement costs.
Comparing the Use of Assets
Gross profit analysis allows you to estimate the effect of changing an asset from one use to another. This could be land, machinery, buildings, cash, or whatever. Below we dissect the question of whether to use a piece of bottomland for alfalfa or as pasture for stockers. The numbers are simply pulled out of a hat to show the technique. Don’t judge their plausibility. Notice that the two options produce similar bottom lines, but the process forces you to ask (and answer) many important questions:
• Which choice is most risky?
• Would your own machinery make hay cheaper?
• Could you raise your own stockers?
• Could you finance stockers yourself?
• Could you increase the stocking rate?
• Could you increase yield?
• Could you cut chemical costs?
• Which gives you most flexibility in the future?
If the mathematics of reducing gross profit to a unit of something tends to slip your mind, remember the following: $/head, $/acre, miles/hour, pounds/square inch, and so on are written like fractions, because they are. The top gets divided by the bottom.
That is commonly said as “forty-eight cents on the dollar” or 48 percent.
The Danger of Gross Profit Analysis
Gross profit analysis tells you what each enterprise contributes toward fixed costs and possible profit. Only the final financial plan, however, really tells you if the enterprises you have chosen will together pay all the fixed costs and actually return a profit. In any case, you must develop a full financial plan to make sure that all your fixed costs are in fact paid. Like any other technical gimmick, gross profit analysis doesn’t replace common sense.
Especially in crop farming, a particular crop may promise a high gross profit but fail all the other testing guidelines because of its use, its nature, or its associated technology. The farmer whose hand calculator proves that cotton yields more bucks per acre than alfalfa on the strength of a gross profit analysis could easily destroy his land by monocropping cotton year in and year out. The family that made a killing in strawberries this year should not necessarily cut down an apple orchard to double the berry crop.
Diversity of enterprises is generally wise as a hedge against changing conditions in the marketplace. Biological diversity is vitally important to sustainable farming and ranching. For both these reasons, relying on a gross profit analysis alone can be dangerous. The use of the remaining six testing guidelines avoids the trap of cash returns at the expense of true biological capital and, eventually, quality of life.
The simple form of gross profit analysis described here has one other obvious limitation, as well. It does not account for time. You cannot of course schedule crops or other operations that demand more labor, equipment, and capital on a given day than you can supply. Use the gross profit analysis, but think and work to achieve both a form of cropping and a selection of input items that pass the remaining six tests.
As you acquire more skill in performing the gross profit analysis, you might find some benefit in analyzing various combinations of crop enterprises as a single enterprise. Likewise, you might analyze different phases of, say, cattle production on the ranch—breeding to calving, or growing calves to eighteen-month-old steers, versus not breeding but buying in young stock, and so on.
Over the years, holistic managers have developed a number of good ideas that have proven helpful in creating and implementing their plans. Here are four that have been put to use in a variety of situations and countries.
Even with perfect planning, if it were possible, things will go wrong and emergencies will arise—in your personal life or in any aspect of your operation. Because one cannot account for these situations in routine decision making and planning, we needed a way to address them that takes into account the fact that people are stressed in emergencies and this clouds their judgment. Allan Savory found a practical way to overcome this dilemma by referring to a profession that has dealt with it for centuries.
Soldiers have long been taught to substitute routines for panic, so when bullets fly they duck and take aim before fear makes them stand up and run. It seems they also learn a routine for thinking when no routine applies. The technique, referred to as a simple appreciation, is standard in British military training.
First, take a deep breath to ease your panic. Then, before you engage in endless and futile discussions, take out a notepad and start writing, using the following four headings:
• Aim. Define your objective in one sentence. What result do you want? If you need more than one sentence, you have not focused enough. Try again until you have your aim very clear.
• Factors. List everything, good or bad, that has a bearing on the situation. Pour your concerns onto the paper without worrying about any particular order or neatness. Don’t be judgmental, and do it quickly. You won’t be looking at what you write again. This step is just intended to get what’s in your head out in the open.
• Courses. Outline any courses open to you that would achieve your aim. You’ll seldom have more than three.
• Plan. After some thought, pick the course you feel is most likely to achieve your aim. Then plan whatever it is you need to do to bring about the desired outcome.
Forcing yourself to go through these steps will clear your head and focus your imagination. You’ll be amazed at the way this simple appreciation brings forth clarity, which days of discussion and worry seldom do.
Changing the way you make decisions doesn’t come naturally or easily. At the first sign of stress, it’s all too easy to revert to old habits. A number of people have found a way around that by using a decision matrix to help discipline them.
The sample decision-making matrix shown in figure 1.5 was adapted from one developed by rancher–educator Dick Richardson in South Africa, where it, or some variation, is widely used. Dick’s wife, Judy, explains how it came about:
After Dick and I watched people struggle to incorporate the testing questions into their daily life, we developed a simple decision-making matrix to assist them (and ourselves) to truly change the way we make our decisions. The matrix helps ensure that we consciously use the testing questions for every decision we make. Of course, even using the matrix requires a degree of discipline initially, but we’ve found that the best motivator for using it is the difference it has made to our quality of life when we use the matrix consistently and for even the smallest decisions.
When you create your financial plan for the year, you are making decisions based on assumptions that may no longer apply months later when you actually implement them. If you recorded your decisions on the matrix, a quick check will warn you that a change may be needed prior to implementation.
A good decision-making matrix also includes space to record the criteria you will monitor to ensure that the decision was the right one. It reminds you to make a conscious effort to monitor your progress, and it helps minimize the chance of argument when management team members have different recollections about what was said.
The Richardsons have also found it useful to include a column in their matrix labeled “Common sense” simply to remind themselves at the outset that if a decision isn’t common sense to begin with, they probably shouldn’t bother testing it.
Figure 1.5. A useful tool for disciplining yourself to continually test your decisions, the decision-making matrix also provides a record you can refer to when memories grow fuzzy on the details. Use the “Remarks” column to note anything you feel is pertinent after considering all the usual factors: common sense, past experience, expert opinion, research, etc.
Once the new decision-making process becomes second nature, you can do away with the matrix in the interest of simplicity and speed. However, you may find the record of your decisions—in particular, the criteria you’ve said you will monitor—to be valuable in itself and continue the practice.
The practice of Holistic Management involves a number of planning procedures. Embedded in most of them, including Holistic Financial Planning, is the informal ritual of brainstorming.
Some people wince at the word “ritual” because it sounds like church, but in fact people use rituals all the time to prepare for ordinary activities. Think of warming up for an athletic event, dressing for a dance, or the daily routines that carry you from waking up to starting work.
The brainstorming ritual is designed to open the minds of planners to new ideas. “Serious” people sometimes shy away from it, but research has shown that the most original and fruitful thinking occurs during moments of humor and playful competition. Since the very phrase “financial planning” tends to produce the opposite mood, a ritual helps. Before grinding your brains for new ways to make money, cut costs, streamline calving, build fence, or lay pipe, try this one to get everyone’s mind in a playful, creative state. The rules are simple:
1. Gather everyone who might have an interest in the task at hand and some people who don’t.
2. Divide the people into groups of five or more (eight to ten maximum), and ask each group to appoint a recorder.
3. Announce a timed competition (about three minutes) for the longest list of ways to solve a lighthearted problem. Any idea will do, no matter how crazy. No judgment will be made. Only the number counts. Pour out ideas. Do not stop to talk or discuss. Here are some typical challenges for the opening competitions:
• What uses could you find for … (some simple object)?
• How would you get an interview with …?
• How might you deliver a proposal of marriage to …?
4. Start the timer, and at the end of the time read the lists and give a humorous prize to the team that came up with the most ideas.
5. Now put the serious problem on the table, and let the groups compete in the same way (for ten minutes), listing any ideas or solutions that pop into their heads, no matter how fantastic.
6. Appoint a facilitator, who doesn’t participate but monitors each group to make sure they observe the following rules:
• Do not allow anyone to judge any idea.
• If a silence develops, don’t allow anyone to start a conversation. As soon as someone talks to break the awkward silence, creativity drops. Some of the best ideas suddenly flow after a period of silence.
• Allow cheating. Using an idea heard from another table can start a fresh run of ideas at your own table.
7. From the final lists pick out the ideas that have potential and develop them.
To emphasize the point that open speculation often produces more than reworking old ground, Allan Savory tells the following story:
While I was touring a ranch in Africa, my host took me to a particularly rough and inaccessible section that he said had no use whatever. It was steep, waterless, full of predators, and a thorough headache to a stockman, but it was beautiful. “Why not put some cabins down there where couples from the city could hide out for a little romance?” I asked.
The rancher, a man of righteous constitution, took great exception to the hint of impropriety, but the notion that natural beauty and tranquility had cash value in themselves stuck. He built the cabins, and within a few years they produced more revenue than the rest of his operation combined. The moral is that pounds of beef per acre or hectare may be only one of a million ways to assess the potential of land and the value of its production.
In a similar vein it might be remembered that when Ebenezer Bryce first looked down on Bryce Canyon in Utah, he could only remark: “That’s a hell of a place to lose a sheep.” Yet how many millions of Americans have driven how many millions of miles for the same view?
Paying employees a bonus based on production, income, or profit is an old idea. Unfortunately, its potential for inspiring people to make their work more productive usually remains unfulfilled—the big bottom-line figure is so remote from daily decision making that most workers never really know how they fit in. All too often if managers push production or income, they also push up costs; or if profit is the criterion for a bonus, it can raise issues of mistrust as to how profit is determined. And there is ample research to show that, while bonuses produce “movement,” they often don’t provide motivation.
If you are intent on providing a bonus, one technique you might consider is a bonus based on a percentage of what we call net managerial income. This is a true measure of managerial effectiveness, and it places a pressure on managers to both increase income and decrease costs. It is determined only from those aspects of income production and cost control that are entirely in the hands of managers and not influenced by owner whims or perks. Additionally, it is true “open-book management” in that all parties have access to the figures.
When managers participate in financial results, net managerial income (NMI) provides a fair measure on which to base their compensation. NMI is the difference between gross income and gross expenses, taking into account only income and expenses under the direct control of a management sector. This could apply to a foreman who has total responsibility for a band of sheep. It could be the managers of farming and livestock divisions in a large operation.
NMI accounting might also recognize the frequently made distinction between “owner control” and “management control.” In this case, for example, the owner oversees such matters as mineral leases, real estate transactions, and futures trading, while a separate management team runs agricultural production.
NMI is the simplest index of managerial effectiveness. Setting up the columns on your planning chart (described further on) to show it graphically month by month can provide a major staff incentive—especially if NMI is connected to financial rewards and promotions.
NMI has obvious advantages because it creates incentives for managers to cut costs as well as raise income and keeps them aware of where the costs are. Unfortunately, though, there is no universal formula for relating NMI to actual staff payments, because not all submanagers control equal shares of income and cost amounts. For the manager of a cattle enterprise, for instance, the main cost may be fixed land payments over which he has no control. If you take land payments out of the cattle account, however, you’ll show an unrealistic net income. In contrast, the manager of a chicken facility may have great control over the big expense of that enterprise—the feed.
You can compensate for such inequities, but often the exercise will cause you to redefine jobs. If, for instance, the person who manages field crops has no responsibility for machinery costs and maintenance, you might want to make that part of the NMI account and grant the authority necessary for controlling those costs. Such reorganization always runs the risk of upsetting entrenched interests. Be sensitive, proceed openly, and make every effort to build trust in advance.
NMI may show what appears to be a very high “profit” because costs not directly under control of the managers are ignored to arrive at NMI. However, those costs are still real and have to be paid before there is any real profit to share. Thus, if you are giving a bonus derived from NMI, it becomes essential to use some formula to account for those “owner costs” or fixed costs not under managerial control before a percentage of what remains is distributed. You could, for instance, determine the bonuses by first multiplying total wages and salaries by two or three and subtracting the total from the “profit” figure. Then you would decide what percentage to distribute. If something like this is not done, the percentage of NMI that could be shared would need to be very small, or it would break the owner. It is better to make an allowance for those ignored costs and then provide for a larger percentage of remaining NMI.
Before combining all your ideas into a single grand plan, you must work out the details of each aspect in terms of labor, quantities, expense, and, most of all, time. There are several forms to help you do this. Time figures critically in all decisions. Workloads that coincide may require more labor. Expenses that come before your products are marketed may require credit. Construction not completed on time can cost you an entire crop.
You will need four different forms to both develop and monitor your plan. A sample of each, reduced in size, is included in appendix 1.B, as follows:
• Worksheets. These are the standard worksheets used to record the detail of every income and expense item.
• Annual Income and Expense Plan. This multi-columned spreadsheet summarizes the figures contained on all the worksheets, resulting in a master plan that relates time, income, expenses, cash, bulk purchase consumable items, and credit. Printed versions are useful for assembling data, but computer spreadsheets can easily be set up to handle the endless modifications and trial plans called for in the planning process. This same form is used as you monitor the plan’s implementation.
• Livestock Production Worksheet. This is really a glorified worksheet for detailing livestock breeding operations.
• Control Sheets. These forms are for reporting items that run counter to plan and recording decisions on corrective actions and who is responsible for implementing them.
Any other forms or scraps of paper should be avoided. They add to confusion and stress, especially in the most difficult part of planning—control. All of these forms are available from the Savory Institute (see appendix 1.B) in paper format or electronically in the Holistic Financial Planning software.
In the following sections, we elaborate on the uses of the standard worksheet and how to use the Livestock Production Worksheet. The other two forms are described in more detail in the next section.
The standard worksheet has columns for the months of the year (you can start with any month to encompass the natural cycle of a task) and rows for different categories of expense, work, income, decisions, or whatever. The possible uses are far too varied to illustrate here. Your whole operation is likely to require dozens of worksheets and many drafts. You can use final drafts not only for assembling the master plan but also as general work schedules, as inventory and budget guides, and as the basis for all ongoing monitoring and controlling. The examples in figures 1.6, 1.7, and 1.8 show something of the standard worksheet’s versatility.
Figure 1.6, for example, shows the biological year for a commercial cattle herd, which is useful because
• It helps in designing a culling policy or when changing herd size.
• It shows animals in each class for figuring supplement quantities, forage needs, and the like.
• It helps you to plan sales policy, holding late calves, breeding back open heifers, and so forth.
When completed, the Livestock Production Worksheet tells you when your expenses and income will occur and predicts the effect of breeding rates, culling policies, and the like over a long period. For example, you can tell at once what effect a 5 percent drop in conception rate this year will have on your herd size in three years.
Figure 1.6. The top line (seasonal year) shows major events in the biological year—calving, weaning, and such. The arrows show when animals progress from one class to another or go to sale.
Alfalfa Production and Sales Plan
Figure 1.7. This alfalfa production and sales schedule uses a strategy for spreading income throughout the year. Later in the planning this could be modified as the cash-flow situation becomes evident.
Fuel Use and Purchase Projections
Figure 1.8. This worksheet shows fuel purchases for ranch vehicles. It projects consumption by various employees, inventories of fuel bought in bulk, cost and timing of bulk purchases, and monthly off-ranch purchases. This illustrates the best way of arriving realistically at both consumption figures and bulk-buying cash requirements. It will require two separate columns on the final spreadsheet—one for consumption and one for expense figures.
Each Livestock Production Worksheet supports two separate columns on the master plan spreadsheet—an income column (to track livestock sales) and an expense column (to track livestock purchases). All other livestock expenses such as feed, medication, and so on are planned separately on standard worksheets.
To develop production plans for each of your livestock enterprises, do the following:
1. Use a separate Livestock Production Worksheet for each enterprise (commercial cattle, registered cattle, llamas, sheep, etc.). Are you sure, from a gross profit analysis, that the production policy for each enterprise is sound?
2. For each Livestock Production Worksheet draw up a standard worksheet with the biological year (calving, weaning, culling, breeding, etc.) clearly laid out, similar to the worksheet in figure 1.6. This helps ensure a clear picture so that you have no confusion on when animals change age, class, and so on. (Note: It’s easiest if you start with the youngest animal class and follow it through its life.)
3. Record in column A on the Livestock Production Worksheet (see figure 1.9) the different classes of livestock that will be on the ranch or farm at any time during the year—for example, bulls (old and young), cows (mature), heifers (bred), heifers (open), male and female calves, steers. Keep the categories in the same order as they appear on your biological year worksheet to reduce the chance of errors.
Figure 1.9. This worksheet tracks a herd for one year divided into three four-month periods according to the biological year described in the worksheet in figure 1.6. It reflects a policy of culling 20 percent of mature cows, 10 percent of female calves, and all unproductive heifers (10 percent of Heifers-1 and 30 percent of Heifers-2). Study the numbers with a calculator in hand until you get the hang of how the numbers develop.
4. Decide whether you are using the worksheet for one year or for more than one year. (You do not have the multiple-year option with the Holistic Financial Planning software, but you can produce multiple spreadsheets to track long-term livestock production.) The form has three similar sections across it. One of these can be used for one year and the other two left blank. Three sections, or one whole worksheet, can be used for one year divided into three four-month periods, as shown in figure 1.9. Alternatively, when you are estimating the rate of growth of a herd over a few years, one worksheet can be used to reflect three years, as shown in figure 1.10.
5. Record the number of animals in each class at the start of the financial year in column C. Look at the biological year worksheet for clarity. Record the age in months for each class in column D. If the animals are mature, you can record 36+. For a group of young animals, you can use the average age.
Figure 1.10. This worksheet tracks a herd for three years, enabling you to work out how fast your herd will grow without buying in cows. Note: Because heifers in row 5 changed age class in March (see figure 1.6) the death loss was calculated later in the year when these animals were Heifer 1 (row 4). Make sure you only take an animal death loss once on each class of stock.
6. Decide on the actual birth percentages you anticipate for all bred females of different age groups. Record these percentages in column B opposite the appropriate females in column A.
7. Estimate the mortality percentage you anticipate with each class of stock and record it in column J. If you’re using the worksheet for three years, do this for each year in column J. If you’re using the worksheet for one year only, use column J in the middle of the year for simplicity and record mortalities as though they all occurred midyear.
8. Next, using the percentage birth estimates (column B), calculate the births expected in the financial year from each group of females bred. Check the biological year worksheet for each group. They may be bred this year but produce no offspring until the next financial year. They may not have been bred last year. When you estimate births from each group, you can generally, for simplicity, group animals born and divide by two to provide an estimate of male and female calves, lambs, and so forth. Record estimated births in column E opposite the rows for male and female calves, lambs, and so on. Record the average month of birth in column F.
9. Plan any livestock purchases that will be necessary during the year and record them in column G. Record the planned month of purchase in column H. Do this in the appropriate row for any class of livestock to be purchased.
10. Next, take each class of livestock—again, it’s usually easiest to start with the youngest—and follow them through the year (refer to your biological worksheet). Note their age at the beginning, add any purchases, and calculate any deaths (from the mortality estimates in column J). Record the estimated number of deaths in column I. Decide if any of that class of animal will be sold, and if so, record the number in column K. Record the planned month of sale in column L.
Check your biological year worksheet to see if the group will change in age class during the year; if so, record this change in the shaded class transfer columns. Record the number passing OUT of that class in the appropriate row. Record the same number IN in the row for the class of stock that they will become. The OUT number must always equal the IN number. Remember if you have already taken off deaths for those animals not to do so again in the class you have transferred them to.
After following each group through the year, record the number you will close with in column M. Record their average age in months in column N. This closing column also becomes the opening column for the next year planned. If you are using one worksheet for a year in three four-month periods, as shown in figure 1.9, close each four-month period in this manner.
11. Check your plans by adding all the figures for livestock you started the year with. Record the total in row 13 (“Total Head”) in column C. Add and record totals for columns E, G, I, K, and M in row 13.
Take the opening total (column C) and add to it the totals of columns E and G. Subtract from this the totals of columns I and K, and the answer should equal the total under column M. If not, you have an error to find! In the case of the shaded transfer columns, merely check that IN and OUT totals are equal. Otherwise, leave them out of the totals in row 13.
12. Next, analyze the sales. In row 14 (“Class of Stock”), record in one of the columns available each type of animal that will be sold. Next, look in column K and transfer the number for sale in each class to row 15, together with the month of sale (from column L). Note that you have a spare row (16) in case more than one group of a particular class is sold. For each class of animal to be sold,
• Estimate the weights and note them in row 17.
• Estimate the price per pound and note it in row 18.
• Calculate the income per animal and note it in row 19.
• Add wool, hair weights, and prices, if applicable, and note them in rows 20–22.
• Calculate the planned gross income for each class of livestock and record it in row 23.
These are the final planned INCOME figures that should be transferred to the main spreadsheet (which the computer software automatically does for you).
13. Analyze the planned purchases. First, record in row 24 the classes of livestock to be bought, using as many of the available columns as necessary. Next, estimate the price per animal and record it in row 25. Calculate the total cost and record it in row 26. To the right of that, record the month of planned purchase taken from column H above.
These are the final planned livestock purchase (EXPENSE) figures, which should be transferred to the main spreadsheet columns dealing with the particular enterprise (the computer software automatically does this for you).
You have some dollars in the bank, some debts to pay, and Christmas is coming. Time to plough paper, sow ink, and reap dreams. As the English poet V. Sackville-West put it in verse:
Under the double spell of night and frost
Within the yeoman’s kitchen scheme
The year revolves its immemorial prose.
He reckons labor, reckons too the cost;
Mates up his beasts, and sees his calf-run teem.
What follows here is a procedure that originated in a series of steps Allan Savory worked out for creating and using a total farm or ranch plan that accounted for both money and biological capital. It differs fundamentally from the usual cash-flow budgeting that agriculture adopted from other industries, which tends to determine priorities in terms of cash and cash return only.
Most cost accounting procedures treat all capital items as “wealth generating” so long as they can be shown mathematically to return enough revenue to pay for themselves and provide an acceptable margin. This approach all too often leads to failure though, because wealth-generating potential also includes such noncash items as soil productivity, water quality, and training.
The common practice also fails to rank investments in relationship to larger goals, or what today is referred to as the triple bottom line (social, environmental, and economic accountability). Again, anything goes as long as it returns enough dollars. Here we try to discover what will return enough in terms of progress toward aspects of a holisticgoal that may not be quantifiable—say, maintaining a diversity of species. This makes a particular difference in funding capital investments. Instead of putting your money into many projects simultaneously, you’ll probably find yourself tackling one at a time but more intensely, as not many are likely to pass the testing guidelines in a given year.
The planning process outlined here represents many years of evolution and the experience of practical farmers and ranchers who have little sympathy for unproductive paperwork. If you find the description daunting, rest assured that it is more straightforward to do than to read about. It will work as well for small operations as large ones and brings the greatest return in times of crisis.
Mental attitude is far more important than financial resources. You’ve got to carry through, be creative but tough-minded, and not fudge to make things look rosier than you know they are. For starters, however, don’t think of the task as a drudgery of numbers and balances. Think of yourself as a conductor about to direct a symphony. You are about to exercise that kind of mastery over your own life and a stretch of land. Art doesn’t get more spellbinding than that.
If you can acquire computer software to handle the main spreadsheets, do it. Any sophisticated spreadsheet program will serve, but we recommend the software developed specifically for Holistic Financial Planning (see www.savoryinstitute.com). Using a computer eliminates the toil of balancing columns and erasing yards of numbers every time you change a detail of the plan. Tedious hours of calculating, locating errors, and redoing work can be discouraging and will drain your creativity.
Don’t try to plan alone. Select a team that is as inclusive as possible without being unwieldy. There are several reasons for this strategy:
• People who become involved with projects at the beginning will care about them and see them through to the end.
• If people are going to be held responsible for generating income or holding down expenses, they should be allowed to come up with the figures that are directly under their control.
• When hard choices must be made, morale will survive much better if everybody understands why and has a chance to work on solutions.
• It takes a lot of work to prepare for good decisions. Information gathering, inventories, gross profit analyses, time sequences—everything that requires a worksheet—might keep one person tied up year-round. A team, especially if it includes people intimately acquainted with field realities, gets through that work faster and better than any individual.
If you haven’t ever done it before, get organized to start planning as soon as possible. After that, you routinely start the process two to three months before the financial year begins. Altogether, the planning isn’t likely to take more than six to eight days of your time, and most of that will be in hours snatched here and there for tracking down figures, thinking through the actions you might take to address a weak link, and so on. The bulk of your time will probably be spent on the first of the three phases that make up Holistic Financial Planning:
Preliminary planning. This phase is devoted to reviewing the current year’s plan, gathering information and figures for the new plan, and testing decisions. It will require at least one team meeting lasting half a day or more to finalize the steps involved, even if only two of you are planning.
Putting the plan on paper. All the thinking you did in the preliminary phase, and all the testing and sorting you did of information you compiled, now comes into play as you put your plan on a spreadsheet. If you’ve done your preliminary planning well and researched the costs involved in the ideas you want to implement, you probably won’t need more than a day or two, using a computer, to complete this phase.
Monitoring the plan. This phase is continuous and generally requires a few hours once a month throughout the year. All the figures you’ve planned must be monitored monthly to ensure that they remain on track, since events rarely turn out exactly as planned. If actual figures deviate from planned figures, take action immediately to get back on track.
Schedule your planning sessions in advance so commitments and deadlines mean something. Take care not to allow too much time between sessions, or your momentum could suffer.
Your planning schedule should include the following:
• A social event, potluck or barbecue, if this is your first time to plan, where you will brainstorm new sources of income and/or cost-cutting strategies. (In subsequent years this will be only an occasional activity.) Keep the atmosphere light. Include families and children. Don’t condemn any of the ideas that arise. Do this well before you start planning if you are brainstorming new sources of income—at least two or three months prior.
• Time to gather information. Alert team members to research or think through everything potentially relevant—gross profits, sales trends, equipment costs, inventories, whatever. It can be extremely frustrating to gather for a planning session on an isolated ranch or farm, only to discover that no one has a clue how much a mile of fence or a new tractor will cost.
• A half day or so, or several briefer sessions, to discuss and finalize the decisions arising from your preliminary planning.
• A day or two of uninterrupted time to create your plan on the spreadsheet. If you are not using a computer, you may need an additional day. Make this a planning retreat and get away from the farm or ranch if that’s what it takes. Aim for reaching this point one month prior to your fiscal year end.
• A final half-day team meeting to make the adjustments needed to make the plan work. Try to work on a computer so you can instantaneously reckon the implications of change.
• Time to organize monitoring and control routines.
• Monthly team monitoring sessions, beginning in the new fiscal year.
In this initial planning phase, you take a hard look at where you are now and where you need to go in the coming year relative to your holisticgoal. You will make a number of decisions that have a direct bearing on the income and expense figures you will enter onto worksheets. This preparation is essential. Forgoing it in favor of planning dollar figures directly on the spreadsheet leads to serious errors. You have four basic questions to answer:
North American English acquired the term logjam from the practice of floating large quantities of logs down rivers to sawmills and ports. Logjams occurred whenever the flow hung up; however, the drivers discovered that these colossal piles of timber would generally move again if they could dislodge the one key log that had stopped the lot. In this case, what you want to ask yourself is whether anything might be blocking you from making genuine progress toward your holisticgoal.
To get your answer, you need to step back from day-to-day operations and concerns to gain greater perspective, much as the logger does in attempting to clear a logjam. He climbs a hill or tree to see which of the thousands of logs floating down the river has caused the blockage. Then he removes the one responsible, and the rest flow. It’s that one log you need to identify so you can progress once more.
Bear these points in mind:
• Sometimes it takes an outsider to see the logjam you can’t see because of your limited perspective.
• Finding a logjam and addressing it effectively is not always as easy, tidy, or obvious as it is in the logging analogy.
In the early days of practicing Holistic Management, the logjam is most commonly related to a failure to change the way decisions are made. The holisticgoal may not have been formed, or there may be no ownership in it because of the way it was formed, and thus there is no inducement to actually change the process of decision making or to test decisions and monitor them. Some people hesitate to state what they want for fear they can never achieve it; some merely withhold their commitment to achieving what they want, for the same reason. Others balk at the responsibility they must assume if they take charge of their lives or businesses. It’s easier to go to the coffee shop and complain about the weather, the government, or commodity prices. If you decide your logjam involves an inability to change the way you make decisions, you may need to allocate funds for further training or coaching or for a facilitator to help your family and staff form a holisticgoal.
Other common logjams bedeviling ranchers and farmers include:
• government regulations that prevent ranchers from running enough animals or using adequate levels of animal impact;
• contractual agreements that lock a farmer into commodity production;
• lack of adequate water supplies, or the ability to deliver adequate amounts consistently to crops or livestock;
• lack of knowledge of viable alternatives to monocropping;
• lack of knowledge about or experience in mixing livestock and crops together;
• lack of knowledge about or experience in handling large herds, especially at breeding and calving, lambing, and kidding times;
• location of the farm or ranch (when producing specialty goods for urban markets);
Figure 1.11. The logjam in this case was a lack of progress due to a hastily set holisticgoal in which no one felt ownership, and consequently decision making had not changed. Thus, $1,500 has been planned for a retreat away from the ranch where all members could participate with the help of a facilitator to coach them through the process. The remaining expenses are considered wealth generating, in this example, because the planning team determined that the lack of these items was leading to such inefficiency that income was being lost.
• brittle-environment ranch too small to be ecologically manageable (that will need to combine with others in order to run a large enough herd to keep land healthy);
• lack of the capital needed to launch a promising enterprise;
• properties too large to be managed effectively by the number of people available or willing to manage them (a common logjam in parts of Australia).
Many of these examples may in fact prove not to be logjams, as some progress, albeit slow, could still be made overall. In that case, they might appear in the “adverse factors” category (see the next section). A failure to change the process of decision making, however, will almost certainly prove to be a logjam, because it’s likely to block progress altogether.
If overcoming a logjam will involve spending money, it is the most important thing to spend money on.
Create a worksheet. Label it “Wealth-Generating Expenses” at the top. In the left-hand column, list any expenses you will incur to address a logjam (if found) and note “logjam” in parentheses beside them. If you have actual expense figures, include them (in pencil), as shown in figure 1.11. If you don’t have actual figures, assign someone to research the costs. Pencil in that person’s initials next to the item along with the date that information should be ready.
This question is similar to the first in that it is asking you to think broadly. In this case, you’re mainly looking for things that reduce overall efficiency and productivity. They are less urgent than something that is blocking progress altogether but still important. If not addressed, they could become a logjam at some point. Review your holisticgoal to see where you might be falling down. Any one aspect that is continually neglected will have an adverse effect on the operation at some point. Common factors adversely affecting agricultural businesses include the following:
• any of the items just listed;
• no time or funds allocated for vacations or to visit parents or grandchildren;
• lack of computer skills;
• lack of communication and cohesiveness as a family
• lack of communications infrastructure (e.g., clear telephone lines) to permit Internet access, fax transmissions, e-mail;
• working environment too toxic (with chemicals) or dangerous (with heavy machinery) to involve the children; and
• lack of expertise and “connections” for marketing value-added products.
If any other factors are adversely affecting the business as a whole, now is a good time to recognize that and to give thought to possible remedies, which may or may not involve additional expenses. For those that do require funds, do the following:
Create a worksheet. Label it “Adverse Factors” at the top. In the left-hand column, list the items that will require money to address. If you have actual figures, include them. If you don’t, assign someone to research them. Pencil in that person’s initials next to the item along with the date that information should be ready. If any of these factors have the potential for preventing you from addressing a weak link or otherwise greatly reducing income, consider them wealth-generating expenses and record them on the Wealth-Generating Expenses worksheet you prepared earlier.
If the gross profit for any current enterprise is not proving to be as good as planned, you will need to determine why and make appropriate adjustments in the new plan or drop it in favor of a higher-yielding enterprise. On the other hand, if your cull ewes sold for considerably more than you planned and expenses were right on target, for example, is that likely to happen again in the coming year? If the ewes brought top dollar because of your marketing efforts—something that is under your control—you’ll be more confident in your predictions. If you lost an entire hay cutting to hail, and most of the next to rain spoilage, what are the chances of that happening again in the next year? Though you can’t control the weather, you do have some control over when to cut and bale the hay or whether to grow hay at all. Should you consider dropping that enterprise or researching insurance options?
Ideally, you want not only to maximize gross profit but also to spread risk by not relying on one high-yielding enterprise to cover all your fixed costs. It would be unwise to commit all your resources—land, management time, and money—to hay production next year because its gross profit was exceptional this year. You would have to decide how much of those resources you would commit and how much should be put into other enterprises to help spread the risk:
Optional Step: Brainstorming New Sources of Income
Most people tend to put themselves and their operations into a well-defined box (“I’m a cow-calf operator,” “I’m a wheat farmer”) and thus limit their possibilities for profit enhancement. Periodically, it pays to challenge your existing enterprises and the thinking behind them, because there may be other far more profitable things you could be doing using the same resource base.
But don’t overdo it. Few operations survive by chopping and changing enterprises every year. Any new enterprise involves a learning curve and will take a year or more to prove out. Brainstorming sessions held every three to five years are usually sufficient. Hold them as early in the year as you can—six months prior to your fiscal year end isn’t too early. You’ll need the time to track down the figures required for planning.
Follow the rules for brainstorming in the previous section, and you’ll generate more ideas than you can ever use. Use the process described below to help you narrow down the list.
Narrowing Down Your Brainstorming List
Here’s how to weed out inappropriate enterprises and determine which ones have the most potential:
• First cut. Drop any ideas that conflict with your quality of life (society and culture test). There are likely to be many if the brainstorming was free-flowing, fun, and irreverent.
• Second cut. Drop the ideas that are patently ridiculous, such as raising purple mice or engaging in the flea circus business. But be careful in labeling an idea ridiculous. Some of the best ideas are often initially ridiculed by people who are the most knowledgeable about the present situation.
• Third cut. Do a very rough gross profit analysis, as you will not have actual figures to use. Look at the remaining possibilities and, thinking broadly, ask what each might bring in as income over and above what it might cost to engage in that enterprise. You want to keep those enterprises that bring in the most income for the least cost because those will result in the most gross profit, which, after covering all costs, will finally lead to a net profit. At this point you’re looking for major differences, not minor ones.
• Fourth cut. Use the rest of the testing guidelines to help you assess whether the likely actions and inputs involved in each possible enterprise will move you closer to your holisticgoal. Would the enterprise use significant energy? Where from and what type? Where would the money come from? Would there be social consequences not in line with your holisticgoal? If any of the tools or actions used in the enterprise would obviously lead you from your holisticgoal rather than take you toward it, eliminate the enterprise for now.
• Fifth cut. You are likely to have only three or four of your original hundred or so ideas left by this cut. Now do a detailed gross profit analysis with well-researched figures, comparing each enterprise to the others and to your current enterprises, to see which ones really do contribute the most to covering your fixed costs and thus provide eventual profit.
• Do a gross profit analysis per 100 cows, acres, or whatever units are appropriate. Consider looking at what each enterprise contributes per dollar or per acre (or hectare) so you can better determine which enterprise to allocate more funds to in the coming year if you know you are limited by money or acreage (hectares). Be prepared to drop any enterprise that is not providing a positive gross profit unless you have a special reason for running an enterprise that costs more than it brings in. It is the gross profits of all enterprises combined that must cover all the fixed costs of the business and provide the excess that becomes your profit. This analysis is particularly important the first time you plan, since you may discover that one or more of your current enterprises is not providing sufficient income to cover fixed costs and is actually draining the business.
Figure 1.12. The gross profit figures listed to the right of the first five enterprises are the gross profits expected by end of year. The notes to the right refer to modifications that will be made in the particular enterprise in the coming year to improve the gross profit. The new bed-and-breakfast enterprise under consideration shows the calculations used in estimating its gross profit. The total gross profit figure includes both the present and new enterprises.
• Create a worksheet. Label it “Gross Profit Analysis” at the top. List each of your current enterprises down the left side and record their gross profit. Note in the row to the right any modifications you plan to make in each enterprise in the coming year as a result of the gross profit analysis, as shown in figure 1.12. List any new enterprises you might be adding, as a result of either your market research or an earlier brainstorming session, and write in the gross profit figures you used in considering those enterprises.
With the gross profit analysis done, you have a good idea of which are your most “profitable” enterprises—the ones that contribute most to covering your fixed costs. And with all enterprises consolidated on the worksheet, you can see how profitable you are likely to be in the coming year. If there proves to be insufficient income to cover your fixed costs (which you will have some knowledge of from past experience), you are in deep trouble. That is a good time to revisit all enterprises and modify them or seek more lucrative ones (see the box “Selecting Appropriate Enterprises”).
Most likely, you have already given thought to what the weak link is in the chain of production for each enterprise—resource (energy) conversion, product conversion, or marketing conversion. Determine what actions you can take in the coming year to address it. Note that some or even all of your enterprises may have the same weak link, often the case with marketing, or that the actions taken to address a weak link in one enterprise may also address the weak link in others.
Selecting Appropriate Enterprises
Before adding new enterprises, or eliminating old ones, bear in mind the following:
• Managerial effectiveness is diluted by the number of enterprises one manager is responsible for. This is especially applicable to small operations with few staff members. In taking on new enterprises, managers are often stretched too thin, which tends to destabilize all enterprises and the business as a whole. One way to overcome this problem is to contract the management of the new enterprise to someone else.
• There is a direct relationship between management effectiveness and the distance to what is being managed. This is the reasoning behind the old cliché that the finest fertilizer in the world is a farmer’s footsteps, which is also the current notion of managing by walking around. Obviously, the more frequent the contact with the enterprise, the greater your chances of spotting trouble early, and the more opportunities you have for finding ways to improve the enterprise.
• It is often easier to alter an existing product, or develop new uses for it, than to create something entirely new. There may well be ways to “add value” to a soybean crop or a wool clip that increases the gross profit on that enterprise with little additional effort.
• Possibilities may exist to collaborate or partner with other related businesses or organizations that produce complementary products or services. You might combine with other producers to form a cooperative to better exploit a niche market, or contract to supply your sister-in-law’s “whole foods” restaurant with organic lamb and new potatoes, smoked hams and fresh corn.
Occasionally, what starts out as the weakest link in a particular enterprise might be addressed quickly and with minimal expense early in the year, and another link then becomes weakest. Determine what action you will take to address that weak link, as well.
Run each of the actions you could take to address the weak link through the following tests, any of which could apply: cause and effect, weak link (social or biological), energy/money source and use, sustainability, and society and culture. Any expenses involved in implementing the actions that pass are considered wealth-generating expenses because they will strengthen the business overall. Thus, these expenses should be given priority in your planning.
Create a worksheet. Label it “Weak Link Expenses.” List all your enterprises in the left-hand column, leaving enough space between them to write in the actions that passed the testing. Determine the costs for implementing each action, and record the figures on the worksheet.
You’ve looked at any logjam that exists and any adverse factors, done a gross profit analysis of all your enterprises, and identified the weak link in each enterprise. You know in your heart what’s right for you. Now you’re ready to put figures to your dreams and craft the plan that will take you closer to your holisticgoal in the coming year.
Few agricultural producers in the world enjoy the high prices for their products that Americans get for theirs. Even fewer worldwide enjoy lower prices for their purchased inputs or easier access to credit. Yet the failure rate of farmers and ranchers in the United States is a national scandal. The excuses are many, but the main reasons are these:
• Allowing production costs (despite low input prices) to rise to optimistically anticipated income.
• Borrowing heavily against optimistically anticipated income.
• Letting the promise of immediate profit mask the surety of damaging side effects.
• Spending little time figuring out the reality on paper. Most of those who do any methodical planning use conventional cash-flow techniques and economic concepts that do not work when the health of land, crops, people, and animals counts as much as cash in the long run.
To counteract these normal habits of mind, you should do the following:
• Calculate your total gross income, then set aside up to 50 percent as your “profit.” The remainder is all you have to allocate for the living and production expenses you are about to plan. This will discipline you to keep expenses below what you’re actually likely to make. Although 50 percent may sound unreasonable, a number of U.S. ranchers have been able to allocate that amount and achieve it. You can, of course, allocate less than 50 percent, and many do. But allocate too small a percentage, and you will expend too little effort in cutting unnecessary expenses.
• Heed this warning: Although you will deliberately seek to keep production costs from rising to anticipated income, your suppliers, salespeople, and consultants will not. They will still push strategies for “higher yields,” “maximum gain,” “heavy calves,” and so forth instead of “greater profit.” You can use their expertise, but make your position clear from the start: “Here are my limits. What can you do within them?” Almost anyone can push production up at increased cost; the challenge is to spread the difference between income and costs and thus push profit up.
• Keep your holisticgoal in mind at all times and test all the actions and tools you plan to use in running any enterprise. This will shift you away from the paper money trap toward solar dollars generated from the land itself, and away from simply living a life toward making a life based on what you and your family value most deeply.
• Work to a predetermined plan and schedule, and stay committed to others on the management team. This will force you to plan openly, thoroughly, and realistically.
Planning decisions that involve limits and trade-offs always take courage and discipline, but the process outlined here will help keep you and your planning team on target. Although you used the testing guidelines to help ensure that your enterprises were sound, some of the tools and actions that govern each expense may need to be tested again as you work out the costs in detail.
The following steps will lead to a financial plan expressed in hard numbers. A worksheet showing how you arrived at your figures must back up all the numbers you enter on the income-and-expense spreadsheet. Each column on the spreadsheet should be supported by at least one worksheet. Where numbers represent inventories such as fuel or feed as well as dollars, you must first plan consumption rates to show how you arrived at the dollar figures. All worksheets should be accessible, neat, and filed so you can later find them when you come to monitoring and controlling the plan to remain on track.
If you are using the Holistic Financial Planning software, some of what follows will be done for you—columns and rows are totaled automatically, and figures are transferred from worksheets to a single income-and-expense spreadsheet. But the following text assumes that you are doing the planning by hand or using a simple computer spreadsheet program to assist you.
By now you should have a fairly good idea of what these figures should be. You will have used estimates in your preliminary planning; now you need to fine-tune them.
• Create worksheets for each enterprise. Fill out one income and one expense worksheet per enterprise, estimating the income and expenses and when they are expected to occur. Label each worksheet with the enterprise name, followed by the word “Income” or “Expense.” For livestock breeding enterprises, use the Livestock Production Worksheet, which enables you to handle the complexity of births, deaths, and changes in age class during the year and also records the costs of any animal purchases. The previous section has examples and directions. (Other costs, such as supplements, feed, veterinary expenses, and so on, would be recorded on an expense worksheet.)
• Create inventory consumption worksheets. Plan the consumption rate for any items you purchase in bulk that are a direct expense associated with an enterprise. This will tell you how much you have to buy and when. Record all figures in pencil because you are bound to alter them later when you have planned your profit and shifted your focus to the whole farm or ranch.
Think of any income sources not related to a specific enterprise, then create a worksheet labeled “Miscellaneous Income.” This could include mineral royalties, sales of junk or old vehicles, interest earned on a savings account, repayments on an employee loan, and so on.
Your main task in this step is to think through each expense you will incur during the year and decide which category it will fall under:
• Wealth-generating expenses are those that would generate new wealth in terms of social or biological capital (by addressing a logjam) or increase your income over and above what you are currently earning (by addressing the weak link in an enterprise), though not necessarily in the coming year. You identified these expenses in the preliminary planning and recorded them on the Wealth-Generating and Weak Link worksheets.
Brainstorming Ways to Lower Your Costs
Profit is derived more from limiting expenses, and not allowing them to rise to anticipated income, than from any other factor in the business. Once you start putting your plan on paper, you’ll almost certainly have to cut some expenses to achieve the profit you seek. That’s why holding a brainstorming session every few years is a good idea. If you are going to be brainstorming new sources of income earlier in the year, use the same session and group of people to help you address current expenses.
Concentrate on big, rather than small, expenses to get the most out of the session. Saving 10 percent on your annual $2,000 phone bill doesn’t begin to compare to saving 10 percent on your $200,000 feed bill. Choose the top five expense categories or top ten individual expenses, or whatever is most helpful to you.
Start with the three-minute warm-up, make sure everyone understands the sort of expenses being considered, then brainstorm ideas for ten minutes. Or brainstorm each category of expense for three to five minutes. To achieve the best results, you need to keep the session lively and fun. Make sure you test any of the ideas you consider implementing.
• Inescapable expenses are those you are legally or morally obligated to meet. They are fixed amounts that cannot be delayed or negotiated, making this category a minor one that may have no expenses allocated to it. Examples may include a debt obligation to a friend or family member, or a non-negotiable land tax. Create an “Inescapables” worksheet if you have any inescapable expenses. List each item, and note payment amounts in the months they are due.
• Maintenance expenses are the remaining direct expenses associated with each enterprise and all fixed costs. They are essential to running the business and maintaining present income levels but will not generate additional income. Most expenses fall into this category: salaries and drawings, fuel, machinery maintenance, insurance, supplementary feed, and fertilizer, for example.
Other expenses include your “fixed costs,” those costs you don’t associate directly with an enterprise. Other expenses might also include those related to the “adverse factors” you identified in your preliminary planning that didn’t qualify as wealth generating but were still important.
Some of these expenses can be grouped together on a single worksheet, labeled “Miscellaneous,” but others will need to be grouped under headings on separate worksheets labeled accordingly. Items such as fuel will require a separate inventory consumption worksheet to work out the estimated use of vehicles at different fuel consumption rates, times of likely bulk buying, and thus when money will be spent. It’s generally a good idea to have a separate worksheet for “drawings” (and a separate column on the spreadsheet) if you are the owner of the business and don’t pay yourself a salary.
Create an income column for each enterprise on the Annual Income and Expense Plan spreadsheet (if you’re using the financial planning software, this is done automatically), illustrated in figure 1.13. The arrangement of columns bears some thought. If you intend to compute net managerial income, you might group together those income columns that fall under one person’s supervision. Other ways to categorize the columns will no doubt occur to you. Create one last column for miscellaneous income.
Carry the income figures from each of the worksheets to the appropriate columns and months of the spreadsheet, and record them in the “Plan” row. Do it in pencil. A lot will change. If you’re using a computer with a conventional spreadsheet program, make hand entries on a spreadsheet, as well, until you know the program has no bugs and you have confidence in it.
Total the income. Add the planned figures down each column and across each “Plan” row. They must match in the final total income figure planned for the year.
An expense you might want to consider is an annual contribution to a depreciation fund, so that when an asset has lived out its lifespan, you have the money to replace it without having to borrow.
Create a worksheet listing the relevant assets, their potential lifespan, the cost of replacing them, how much you plan to contribute to the fund this year and in what months, and head it “Fixed Cost—Depreciation Fund.” If you wish, you can actually “spend” this money by placing it in a tax-free, income-bearing investment until needed. Or you may choose to invest in the growth of your own business by moving these amounts to wealth-generating expenses. By going through the exercise, you become aware of when machinery is likely to wear out and can plan when to replace it without having to borrow the funds to do it.
Annual Income and Expense Plan
Sheet has 12 months vertically and 28 columns horizontally per page
Figure 1.13. This is the master spreadsheet on which you enter the figures summarized on your worksheets and track them through the year.
This will be the first column on the expense side of your spreadsheet, and it is the most important expense (or expenses) you have. Label it “Logjam.” Transfer any expense figures from the Wealth-Generating Expenses worksheet associated with the logjam, and record them in the “Plan” row in the appropriate months.
In Holistic Financial Planning, you plan the profit before allocating any money to expenses other than those associated with a logjam. Your sole purpose in taking this step is to place a ceiling on how high your expenses can rise. To proceed, do the following:
• Reduce the gross total on the income spreadsheet by up to 50 percent, as shown in figure 1.14. Set that as your limit for the remaining expenses you are about to plan. This will discipline you to keep expenses below what you’re actually likely to make.
Planning Your Profit (No Debt)
Figure 1.14. For some people, setting aside 50 percent of total income as profit provides a doable challenge; for others, 50 percent would be demoralizing—20 percent or 30 percent would provide challenge enough.
Planning Your Profit (and Debt Servicing)
Figure 1.15. If a large portion of your income must go toward servicing debt, first subtract annual debt payments from the total income figure, and then determine how much of the remaining amount to set aside as profit.
• If you carry a big debt, the amount of money remaining after you cut the projected income and subtracted loan payments would be so small it would depress rather than challenge you. Since the point of cutting income by up to half is to encourage thrifty thinking, subtract the debt payment first and cut what’s left, as shown in figure 1.15.
• Record the amount of profit you plan to set aside in the next column on your spreadsheet (or make it the first column if you had no logjam expenses). Label the column “Profit” and enter the figure in the “Plan” row under the months you plan to set it aside.
Allocate what you must, as these are by definition unavoidable expenses; you don’t need to agonize over them. Nevertheless, take the time to assure yourself that they are in fact unavoidable. Financing and structuring debt, for example, is a complex art. Have you really researched and explored all options? Converting debt to equity, equity financing, and lease-back arrangements will not necessarily be suggested by your major creditors. If stuck for ideas, don’t hesitate to gather some friends to brainstorm your way out.
Transfer the expenses listed on your “Inescapables” worksheet to the spreadsheet’s next column, labeling it “Inescapables” and noting the figures in the “Plan” row in the appropriate months.
Transfer the wealth-generating expenses first. Divide these expenses into two groups: those that must have 100 percent of the money needed or they won’t happen, and those that could work with a partial allocation. In the first type, allocate all that is needed. If a training program costs $1,000 and you allocate only $500, it won’t happen, so allocate the full $1,000.
For those wealth-generating expenses of the second type, make a good guess of the minimum funds you can allocate, with the full knowledge that the amount will likely increase before the planning is over. An example of this sort of expense would be fencing that is addressing a resource-conversion weak link. If you allocate the maximum dollars to this expense, you will run out of money before all maintenance expenses are covered.
Transfer any “adverse factor” wealth-generating expenses listed on the Wealth-Generating Expenses worksheet to a column labeled “Adverse Factors,” and enter the figures on the “Plan” row in the appropriate months.
Transfer the weak link expenses associated with each enterprise into individual columns labeled “WL” plus the name of the enterprise. Because you will have other expenses associated with each enterprise, make sure you leave several blank columns following this one so you can keep enterprises grouped together. Count the remaining worksheets you have for each enterprise so you can determine the number of blank columns needed.
Transfer the figures on your enterprise expense worksheets to columns labeled with the headings used on each worksheet (see figures 1.16 and 1.17). Don’t forget to transfer monthly consumption figures—in volume, number, or weight, rather than dollars—to their separate columns so you can monitor consumption throughout the year. This helps avoid the unpleasant surprise of having to bulk-order fuel, for example, two months before planned. Record everything in pencil.
Figure 1.16. The data from the worksheet in figure 1.17 would look like this when entered on the annual expense plan. Note that inventory consumption figures and actual purchases appear in separate columns, which enables you to monitor consumption so you can avoid unplanned expenses.
Worksheet Figures Transferred to Spreadsheet
Figure 1.17. All the expense and consumption figures have been transferred from this worksheet to the appropriate columns in the expense spreadsheet in figure 1.16.
Transfer the expenses from the worksheets that list all your fixed costs. Make sure that each column carries the same name as the worksheet that backs it up. And don’t forget to include columns for any inventory consumption worksheets.
Total the expenses. Check your figures. Total the columns and rows. The sum of the row totals and the sum of the column totals must be the same. Ferret out the mistakes and enter the grand total in the lower right corner of the spreadsheet. If you do this by calculator, use one that prints a tape, it makes finding errors vastly easier.
Once all expenses are recorded and totaled on the spreadsheet, you will know whether your income covers them. If it does not, as is likely, your challenge now is to cut, paste, compromise, and fit everything into one holistically sound plan. In doing this you will inevitably modify some of the work you did in earlier steps, so don’t take it personally when erasers get worn out on things you put a lot of time into. The work was not wasted. Let’s say you figured out how to build thirty miles of fence but end up putting only twenty on the plan. You can’t make that kind of decision at all without thinking through the bigger plan.
Start with the maintenance expenses. Cut out any that aren’t absolutely essential to each enterprise or to running the business, or that can be put off for another year without damaging the enterprise or the business as a whole. You are challenging all maintenance expenses here, and nothing is sacred—even routine expenses don’t necessarily have to continue.
Use the marginal reaction test. Apply any excess gains (from your maintenance expense cuts) to those wealth-generating expenses that received only minimal funds but needed every dollar they could get. Apply the most dollars where they give the highest return in terms of your holisticgoal. Every dollar you can move from a maintenance expense to a wealth-generating expense without losing effectiveness will grow the business to a new level.
Use the marginal reaction test to compare the wealth-generating expenses within each enterprise, and eliminate any that provide only a modest return in favor of placing every dollar you can where it provides the highest marginal reaction.
Use the marginal reaction test to compare the wealth-generating expenses across all enterprises. Identify those that provide the greatest return to the business as a whole, and eliminate the others. This suggestion is counterintuitive. You will be tempted to keep all wealth-generating expenses. If your holisticgoal listed profit as a form of production and you are serious about achieving it, don’t.
Consider reducing your profit if you will be putting that money toward one or more wealth-generating expenses. In doing that, you make the decision to invest your profit in growing the business. Just make sure you’re doing it intentionally and not just letting the expenses rise to the total income planned, as it is all too human to do. If you do intentionally make this choice, which is often wise, don’t later complain about the lack of profit.
When the plan is in balance and you have ensured that your income will cover all expenses, determine how best to invest the planned profit. If, in the previous step, you didn’t consider reinvesting your profit in a wealth-generating expense, consider doing so now if you want to grow the business. You might also plan to invest some or all of your profit elsewhere to spread your risk or to maintain some liquidity in case of emergencies. Bear in mind the tax consequences at the end of the year.
You have now laid out your proposed business year in its entirety. Take a good look at it. Even if the bottom line comes out positive, you don’t know if you will have cash on hand when you need it or what your monthly credit needs will be.
To analyze your cash flow you will need to create two columns at the far right end of your spreadsheet, labeled “Monthly Surplus/(Deficit)” and “Bank Balance” (see Example A). If you know that you will need to borrow funds, whether as a line of credit or through overdraft facilities at your bank, or a note of any kind, skip this step and go to Step 13.
• Monthly Surplus/(Deficit). Calculate this for each month separately, and don’t connect any one month to the next. Subtract the total expenses from the total income for the month, and record the result in the column for the month in the “Plan” row. If it is a negative figure—that is, more expenses than income—place parentheses around it.
• Bank Balance. Start with zero, or whatever cash you estimate or know will be on hand at the beginning of your financial year. Record this figure in the block just above the first “Plan” row. Next, add or subtract the monthly surplus or deficit you have planned for the first month. Enter the resulting planned bank balance, which will be the predicted bank balance at the end of the first month, on the “Plan” row of the “Bank Balance” column.
Successively calculate and record the figures for the remaining months. Make adjustments in any month in which income will be insufficient to cover expenses (the figures will appear in parentheses). You can do this most easily by rescheduling purchases, but some income items might be rescheduled to come in earlier. Be careful about that, however. As a general rule, income tends to come in later than planned, and expenses tend to come in earlier than planned. Make sure that the calculations you use in making any adjustments are recorded on your worksheets before transferring the final figures to the spreadsheet. If you find you cannot juggle figures sufficiently to avoid deficits over several months, you will have to borrow enough to get you through those months—either from overdraft facilities at your bank or by means of a short-term loan (covered in the next step).
Note: If you have made any adjustments, recalculate the total figures along the bottom of the sheet (for both income and expense columns) and across all “Plan” rows, and make sure the totals across and down are the same. (This will be done automatically if you are using the Holistic Financial Planning software.)
If any borrowing is involved, you must work out the full cost of that borrowing by calculating the monthly interest. In addition, by manipulating the cash flow, you may be able to reduce the peak of indebtedness.
Do the monthly analysis of the debt on the spreadsheet, to the right of all the expense columns. A number of variations are possible. The number of columns you need for analysis will depend on your financing. If done through the bank by simple overdraft, you will need three columns. If done through the bank by a note or loan, you will need five columns. If you have more than one note or loan, you will need more than one group of columns. In all cases, you use essentially the same procedure outlined here.
Simple Overdraft
Use three columns headed “Monthly Surplus/(Deficit),” “Bank Balance,” and “Bank Interest Owed” as shown in Example B.
In the “Monthly Surplus/(Deficit)” column, calculate the surplus or deficit for each month separately; do not connect any month to the next. Subtract the total expenses from the total income for the month and record the result in that month’s “Plan” row. If it is a negative figure—that is, more expenses than income—place parentheses around the figure.
If you have no overdraft to start: Just below the “Bank Balance” heading, above the “Plan” row, record the amount of cash you estimate will be on hand to start the year. Then add or subtract from that amount the monthly surplus or deficit planned for the first month. Enter the resulting bank balance on the “Plan” row of the “Bank Balance” column. Then successively calculate and record the figures for the remaining months.
If you have an overdraft at the start or in subsequent months: From the “Bank Balance” column, take the figure of the last month of the previous year, or the first amount in overdraft (this should always be in parentheses to indicate a negative figure) and calculate the interest on the overdraft for that month by using the following formula: annual overdraft interest rate × planned overdraft divided by 1,200. For example, if the annual overdraft interest rate equals 13 percent, and the predicted overdraft at the end of the first month = ($20,342), then interest on the overdraft for the month would be calculated as follows:
Enter the interest calculated on the “Plan” row for the month in the “Bank Interest Owed” column (Example C).
To calculate the interest for the next month, start with the overdraft and interest predicted for the present month. Add that interest to the overdraft and then add the monthly deficit or subtract the monthly surplus for the next month. Enter the expected overdraft on the “Plan” row in the “Bank Balance” column, as in the following example:
Overdraft of month one = |
(20,342) |
Add interest for month one of $220 = |
(20,562) |
Subtract surplus in month two of $6,503 = |
(14,059) |
This amount becomes the planned overdraft or “Bank Balance” column amount. Then you can calculate and enter the interest expense of $152 for month two (Example D).
Assume that in month three the monthly income exceeds monthly expenditure by $15,000. The month’s surplus is thus $15,000. That would give us the following calculation (as shown in Example E):
Overdraft end of month two = |
(14,059) |
Add interest for month two of $152 = |
(14,211) |
Subtract surplus in month three of 15,000 = |
789 |
The bank balance is now positive and is not entered in parentheses, nor is any interest calculated once the balance is positive. From here you would proceed with the calculations for the following months; but if you were to go into overdraft again, you would once more calculate and add interest charges.
Cooperatives and Similar Facilities
Some businesses use credit facilities offered by cooperatives or other lending sources that charge interest, which would give you the equivalent of overdraft facilities from more than one source. Although it’s possible to predict the overdraft from each source separately, that complicates the arithmetic while not really improving the planning. We suggest you treat all similar credit facilities as one for cash management analysis, and that you use a single interest rate. Then use the same procedure you would use for a simple overdraft.
Loans and Notes
If you have a loan or a note, use an additional three columns to the right of the “Bank Balance” and “Bank Interest Owed” columns, headed “Loan Payments,” “Loan Balance,” and “Loan Interest Owed.” Use the same procedure you would use for a simple overdraft, adding to or reducing the note as you wish in particular months to plan and calculate interest on the note balance. In Example F, the opening debt is $100,000; the interest rate is 12 percent per annum, charged monthly; and the repayment is $2,000 per month.
When an adjustment down is made to the principal amount of the loan in any month, that payment must be reflected in the “Bank Balance” column, because a reduction in loan liability will usually be offset by a decrease in funds available in the bank account.
Your plan is not complete without first making two important checks:
• Is the plan sound when projected forward? At this point your plan represents the actual cash flow into and out of the business, including the level of borrowing, if any, and when debt will peak during the year. Although the plan might look good now, you won’t know if it really is good until you project it ahead several years to see whether it contains any distinct trend that leads to heavy borrowing. Doing this forward projection is relatively easy; it takes far less time if you have entered all your figures onto computerized worksheets and spreadsheets.
To project the plan ahead, transfer the income and expense figures you have now to new worksheets. Then go through each item and make the changes that you know will apply in the following year. For instance, if you are running livestock and you included buying a scale and five new bulls in this year’s plan, you know you can delete those expenses from next year’s plan. On the income side you will need to rework the Livestock Production Worksheet so you can accurately assess number of animals, hides, amount of wool, and so on for sale in the following year.
When you have made all the adjustments you can foresee and transferred them from the worksheets to the spreadsheet, simply look at the bottom line, the rate of payoff of any loans, and the peak of indebtedness during the year. If those look satisfactory, repeat this whole process for the year after. Continue to repeat this process for as many years ahead as you need to in order to get a clear idea of the trend of the business.
• Is the plan sound from an overall business point of view? Will the plan produce a profit or loss in real terms at the end of the planned period? Will it leave you in an acceptable position in terms of your holisticgoal?
Remember that while you may have allowed for depreciation in real terms, you have not used government depreciation tables nor accounted for increases or decreases in net worth on the spreadsheets. Any items deliberately held back from sale, or unsold products held in storage at the end of the year, will represent an increase in wealth, although not yet reflected in cash.
To know how profitable the year is really planned to be, start by calculating the difference between the opening and closing (beginning and end of year) values on all business assets, including unsold or held-back inventory. To the resulting figure add any cash excess planned and deduct the allowable depreciation on any assets. This final figure will give you your answer.
If you have any doubts, have your accountant review the plan and assist you; your spreadsheets and worksheets should contain all the information he or she will need. Knowing what the likely tax consequences of your plan are going to be will prove useful. It is for this reason that the planning should be completed at least a month prior to the end of the fiscal or tax year; it gives you the opportunity to push some expenses forward to the next planned year, or to arrange purchases before the end of your current year. In doing these things, you do not avoid taxation, but you can delay it to the benefit of your business.
If, after this final analysis, the plan looks good, then proceed. If not, replan right away. Replan until the results satisfy you. This replanning requires a great many adjustments and erasures of all those figures you wrote in pencil on the planning sheets (if you do everything by hand). Now, just when you need all the energy and creativity you can muster, you can easily fall into bitter arguments with your team members over how to cut and paste. Before that happens, consider the following:
Many planning teams have found that extremely well articulated arguments often have nothing to do with the plan. They are trumped up mainly to avoid the agony of reworking the plan. If you haven’t already done so, consider getting a computer. Then you only have to fight over who gets to use the machine. Just punch in the suggestions, and see if they work.
No plan ever goes exactly to plan. No planning is complete without monitoring, controlling deviations, and replanning when necessary. Before your new financial year begins, schedule monthly monitoring sessions and follow these guidelines:
1. Establish the most convenient means to obtain, before the tenth of each month, the actual income, expense, and inventory consumption figures.
2. Enter your figures in ink on the second row (labeled – “Actual”) of the spreadsheet (see figure 1.18).
3. For each month compute the difference between the planned and the actual amounts. Enter the result in ink in the third row (labeled “Difference”). For all income and expense columns, enter figures that are adverse to plan in red ink and those that are on or better than plan in blue, so your overall position will be graphic.
Monitoring Planned Versus Actual Figures
Figure 1.18. This plan shows the relationship between planned and actual income figures for cattle and planned and actual production and income for alfalfa.
4. After the first month, record the accumulated difference in the fourth row, again using red or blue ink. This is the sum of the differences in the preceding months. It will alert you when small differences ignored in your monthly control represent a serious drift away from your plan.
This is not an accounting procedure. Rough figures now serve better than perfection a month late. You may use the normal bookkeeping process, but sometimes check stubs or other tallies work well enough and faster.
One look at the planning sheet and its red and blue entries will show you the deviations from plan at a glance. Consider all the major adverse deviations in detail, column by column, going back to the original worksheets (which you have carefully filed) as necessary. At first the deviations may derive from inexperience, but as the years pass, you’ll get better. In any case … do something now!
If the income items are seriously adverse, they can be “controlled” only by cutting total expenses. This will require you to replan, perhaps from scratch. If the expense items are adverse, always control the item itself. You must never simply eyeball the numbers and balance a surplus in one column against a deficit in another. The general rule is control within columns, not across columns. Any deviation adverse to plan—fuel cost is a common one—must be controlled and brought back to plan. You cannot let a deviation pass on the excuse that a surplus for the month exists in some other column. You want to accumulate any surpluses you can, as they may be needed later in the year. If you don’t keep every expense on target, you’ll soon lose control of the whole plan.
It is crucial to apply the utmost energy and imagination to get things back on track. Mental attitude counts more than anything. Don’t hurry.
Don’t panic. Think, think, think. Plan, plan, plan. Neither make, nor accept, any excuses. The word “can’t” must not enter your head.
Serious deviations from plan also constitute the greatest danger to management relations and the morale of your whole staff—another reason for careful monitoring. The temptation to assign blame quickly and to reprimand somebody will be great but likely as not will ensure your ultimate failure.
The best solutions often lie in a flexible and cooperative sharing of time and resources commanded by several staff members, rather than merely turning up the heat on the one person in whose area the problem technically occurs. Anything you do now to exacerbate unhealthy competition, resentment, or turf battles among staff could prove fatal to your operation.
Figure 1.19. The control sheet should be used for controlling major deviations from plan, which become obvious as you tally the actual figures in each spreadsheet column each month. If minor deviations accumulate, which you will pick up in the “Cumulative Difference” row in each spreadsheet column, transfer the amount to the control sheet so it gets attention.
Make the problem a matter of shared concern and responsibility and invite a team approach to solving it. This is where the “goal ownership” you have hopefully built over the years pays off in spades. Every crisis offers an opportunity for staff members to show their stuff. And seeking their input, rewarding creativity, and delegating authority builds morale as surely as tyranny tears it down.
Generally—and certainly where a management team answers to a board or absentee owner—a monthly Control Sheet, shown in figure 1.19, should be completed. This form states the column heading or number, the amount of deviation to date (in dollars, gallons, tons, etc.), the cause of the deviation, and the proposed action. Last, but most important, decide who is to act and note that person’s initials in the “Act” column.
Consider devoting time in each monitoring session to look ahead to the coming months. Things you planned last November to have happen in June may need attention now to make sure they do happen as planned. The rains may not have come, and wool prices may have collapsed; the situation may be different from what you planned. The plan will have a much greater chance of success if you go through it carefully each month, looking ahead to see what needs to happen, and noting those things in your time planner to make sure they do happen.
Although money itself represents neither wealth nor the fulfillment of dreams, it can be a measure of progress along the road to those things, and so you must plan. When farms and ranches representing the lives and dreams of generations go down to the mournful echo of the auctioneer’s hammer because no one saw the danger ahead, we talk of economics as an evil that grabs people by the throat in the dark. Yet you know that is not true. Just turn on the lights. Do the financial planning. The monster vanishes.
You can’t manage in the dark. If you can’t see all the pieces at once, even the notion of holism becomes absurd. Do the financial planning.
Allan Savory, who originated these procedures and has seen them return many an apparently hopeless case to the glory road of prosperity, often rails against the lack of self-discipline of well-endowed managers who don’t plan. The people whose bones now bleach beside the road (more men than women) spent too much time drinking coffee and tinkering with machinery. Do the financial planning.
Most nonplanners probably don’t lack self-discipline. When Sam Bingham doesn’t plan, it’s often because between him and those he cares for, be they family or associates, there is a no-man’s-land of competition, disagreement, or ambiguity that they dare not enter. Nothing lights a fuse quicker than money.
“If my wife knew the size of our debt, she’d faint.” “Maybe—if we have enough left after the calves are sold—I’ll get my daughter a car to take to college, or we can go visit my wife’s parents, or lay that pipe from the spring.” If you wait till fall and the money is or isn’t there, then you won’t have to argue about it, right? Or if there is an argument, the winners will spend the money and what happens then will be their fault. Either way, why stir things up now?
Because if you do, and you really can bring people together, set a holisticgoal, and eliminate the no-man’s-land of silence, the planning won’t require any self-discipline at all. Economics, which is no less a part of life than love, will be on your side. Switch on the lights and do the financial planning.
