February 3, 2020
Sara Schafer
Use this financial metric to balance risk and growth
Are you vulnerable, reactive or proactive for growth? In today’s environment of tight margins and split-second opportunities, you need to work toward being proactive, coaches David Kohl, professor emeritus of agricultural finance at Virginia Tech University. Do so by monitoring a few key financial metrics.
“One of my favorite ratios is term debt to EBITDA, which is calculated using all term debt divided by EBITDA,” he says. “If the term debt to EBITDA ratio is greater than 6:1 post expansion, then the growth might be placing your business in a risky position if any adversity were to occur over the long term.”
EBITDA is earnings before interest, taxes, depreciation and amortization are deducted. It shows the amount of earning available for repaying debt. It also lets you focus on the outcome of your business decisions, says Alan Grafton, director of K•Coe Isom’s AgKnowledge.
“You want to calculate your EBITDA the same time every year and watch the trend,” he says. “If it was $500,000 one year and then $600,000, what caused the change?”
Mind the Trend
By tracking your EBITDA trend, Grafton says, you can dig into the why behind the results of your
management decisions. You can also see what areas of your operation you could set goals to improve.
Involve your lender in calculating and monitoring this metric, Grafton says. With today’s thin profit opportunities, a guess at your financial standing won’t cut it.
“You cannot look at your financial practices only once a year,” Kohl adds. “You have to constantly monitor them. What created deviations? Was it related to a management decision or external factors out of your control?”
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