Organic Business Guide/Planning and managing your business
Planning and managing your business
In the end, the success of any organic production initiative depends on whether you are able to run it as a sound and profitable business. Some entrepreneurs get a long way working on intuition, but sooner or later everyone needs to think through their business in an organised way; have a strategy, a plan, an organisation, proper financial management etc. In this chapter you will find some guidance and tools for developing the most crucial aspects of a business strategy and plan. They will help you to make better decisions concerning the set-up of your business, to defend your sales prices when negotiating with buyers, to apply for investment and trade finance, to monitor the performance of your business and to adjust it to a changing market demand.
Developing a business strategy and plan
Some entrepreneurs and producer organisations are scared by the term business plan – they are afraid of a big, theoretical and inflexible thing. Everyone knows successful entrepreneurs who never prepared a business plan, but succeeded because they had the strategy and figures in their head. There are also experiences with projects which had a 100 page business plan written for them by a hired expert, but completely failed because the plan was not realistic, or not understood and not internalised. Developing a business plan is crucial for an organisation in which more than one person is involved, such as a producer organisation. It will help the organisation plan its activities in order to generate a better income for the involved producers. Once the business has started it will help you monitor the progress and profitability of the business and to adjust your planning where necessary; in short it will help you to get and keep your business on track.
A business strategy
Any business needs to have a fairly clear idea how it wants to develop. Whether you call this a business plan or not, and to what level of detail you develop these ideas depends on the size of the business, whether you have investors or a management body to answer to, or on the need to convince banks or donors that your business case is viable. If you have an existing business and want to start an organic unit or expand your production capacity a feasibility study, cost price calculation or adaptation of your existing business plan might be sufficient.
The minimum you need in terms of a business strategy is to have fairly well thought through ideas on the following points:
- What is your core business (products, processing, trade)?
- What is your market, who are your competitors and how can you compete with them?
- How do you organise your business (legal and organisational structure, who does what)?
- What will be the size of the operation (number of farmers, production volumes), and what growth do you envisage over time?
- What are the estimated costs and revenues over some years, and when will you break even?
- What price do you need to get for your product(s) to cover your costs, and to make a reasonable profit reflecting the risks you take?
- What finance do you need to start your business, and where will you get it from?
- How will you manage your cash flow, and how do you propose to bridge possible shortages of cash at certain times?
- What marketing activities do you need to take up, and what resources do you need for this (see chapter "Marketing strategy")?
- What risks are involved in doing this business, and how can you reduce them?
- What happens when you miss the projections you made; what is your plan B?
Preparing a business plan
The extent to which the business plan is written out largely depends on the requirements of the agency providing the finance. If you want to apply for a loan, investment or other external finance, a fully-fledged business plan is clearly needed. You need to convince the bank or investor that your business idea is viable and that the investment will result in a profitable, sustainable business. In this case it won’t be sufficient for you alone to be convinced; the case needs to be properly presented and documented so that it convinces others. In addition, a business plan is a valuable planning and strategy development tool that will help you to be successful in doing business.
A good starting point for a business plan is to conduct a SWOT-Analysis of your business idea (Figure 10). In this process you do not only analyse the strengths, weaknesses, opportunities and threats of your current business, but also take into consideration the situation in the market (preferences, trends), the position of competitors, and the prevailing business environment (legal framework, services). Strengths can be used to capture opportunities, while weaknesses may pose threats to your business idea.
Starting from the SWOT-Analysis, you can develop the business plan step by step. An outline of a simple business plan for an organic business is provided in Annex "Business Planning". Sources that provide general guidance on business planning are listed in Annex "Useful references and websites", Business planning and management.
A business plan is not of much use if it is not understood by the people who are supposed to implement it. Developing a business plan needs to be a participatory process which helps those involved to gain an in-depth understanding of the business case and its challenges. They will then know almost ‘off by heart’ what the direction is for the next few years. The process of developing the plan happens in loops of brainstorming, analysing, structuring, testing, revising; it is more important than the final document itself.
Successful businesses do think through their plans themselves. It may be a good idea to involve an external expert in developing the business plan, to get an outside view of your business model as well. Make sure that you keep ownership of the process, and that you understand each aspect of the plan - especially the financial ones!
A business plan is not only a feasibility check and a way to plan your business, it is also a management tool which helps you to focus on the most important aspects, to keep the core figures under control, and to help you adapt to the ever changing business environment. A business plan is also not a one-off exercise put in the drawer once the bank or the donor is convinced. You should live by it, implement it, periodically update the core figures at least, especially those concerning production volumes, costs and revenues, and check that it is still viable. Dare to adjust projections downwards if that will give you a more viable business case. Especially when one of your key drivers behind the business turns out not to be feasible, it is important to adjust your business case, inform your investors or financiers and discuss possible solutions.
Setting up your operation
This sub-chapter deals with what you need in order to start an organic business, or to convert an existing product line to organics. It also covers how you organise the different elements, and who plays which role.
Elements of the organic business
An organic business consists of several core elements that are interlinked with each other (Table 1). Obviously, first of all you need farmers from whom you will buy. Ideally, the farmers are not only producers but are also involved in post-harvest operations, in bringing the product together (bulking), and in ensuring the organic integrity and the quality of the production. Farmers need to be partners in your business - depending on the set-up of the business they can even be owners or shareholders of the business (see chapter "Involving farmers").
The field staff is in charge of training the farmers on organic farming methods, and provides technical advice as per the farmers' needs. It encourages experimentation and supports farmers to exchange information among themselves. Extension is closely linked to the Internal Control System (ICS), which is a requirement for organic certification of smallholder groups. The ICS is a tool to manage the integrity of the organic production and ensures traceability during buying. The ICS can also be used to monitor and improve the quality of production (see chapter "Developing an internal control system").
The core of an organic business is the buying of raw materials from approved farmers on the one side, and the selling on of that product after some cleaning, processing and packaging on the other. In addition to dealing with the product, some businesses also provide inputs to the farmers, such as seeds, natural fertilizers or tarpaulins for drying (see chapter "Challenges in organic production"). The buying and selling activities include securing trade finance, logistics and storage.
Most organic businesses also engage in some kind of processing of the raw product as delivered by the farmers (see chapter "Processing and value addition"). This may range from simple cleaning and grading, up to the production of finished products such as juices or honey in jars. Proper quality management at this level is crucial for being successful. Processing also includes the packaging of the product into units for sale (bales, bags, containers, boxes etc.).
The activities and transactions within the above mentioned business elements require a certain level of administration and management. An organic business requires a higher level of management than in a conventional agri-business of the same type and size. There is a lot more to manage and a lot less space to fiddle as there is an annual inspection (including of the books) for certification. You need to ensure that finances are properly managed and that production and sales figures are correct and available on time.
Running an organic business is almost never a one-man/woman show. You need to have a certain number of staff that will need to be managed (recruitment, employment contracts, training, incentives, etc.). "Human Resource Management" may seem to be a big term for small businesses, but it is not only about hiring and firing people. The quality of the staff determines the success of the enterprise, whether it is a cooperative or a private company (see chapter "Staff development"). The management has responsibility to ensure that the system works, the plan is implemented and is also responsible for the enterprise’s strategic development. The management also represents the business to the outside world, and develops linkages and alliances with other stakeholders (see chapter "Management structures and capacity"). In Annex "What you may need for an organic business" you will find a detailed checklist of what resources you might need for an organic business. It should help you not to forget any important elements. If an existing business develops an organic product line, many of these are of course already in place.
How do you organise your business?
How you organise the different elements of your business depends on the size and scope of your operation - the smaller it is, the less organisational units you may require. However, even if one person is in charge of several functions, it is still advisable to have a clear idea of the different organisational units. Extension and ICS may be organised in one unit, and similarly processing and trade (unless processing is a major activity of your business). The organisational chart (Figure 11) provides an overview on how the key functions of the business are typically arranged.
Keep it as slim and simple as possible! In a small start-up, combine functions rather than hiring too many staff. The director, for example, can also manage accounts and marketing, and another person can be in charge of production and processing. Once the business grows you may hire additional personnel who take over specific functions.
Defining roles and responsibilities
For the smooth functioning of your business it is important that each person involved has a clear idea on his/her roles and responsibilities. Ideally, each person working in the company has a job description (or terms of reference) that clearly defines the duties and competencies needed (see texample in Annex "Job description for field officer").
Once the business gets bigger and more complex, it can be useful to document the main structures and processes in an operating or quality management manual. The manual describes how the business is structured and organised, who has which responsibilities, and how the main processes (production, extension, internal control, processing, trade etc.) are done. The text part of the operating manual refers to separate documents such as organisational charts, job descriptions, internal regulations etc. An example of a Table of Contents of a typical operating manual is provided in Annex "Content of an operating manual".
Most certifiers will require that the procedures of the internal control system are clearly defined and documented. This can be done in a separate ICS manual, or integrated in the operating manual or the quality management manual. As the ICS usually involves documents such as forms, standards, checklists etc. which are updated from time to time, the manual helps to keep an overview of the different documents and versions that are in use (see chapter "Developing an internal control system").
Preparing the operating manual helps you to think through the different aspects of your business, to identify ways of making it more efficient, and to keep an overview of the complex operations. The operating manual makes it easy for outsiders (e.g. the certification body or the bank) to get a clear idea on how you function. It also helps you to make new staff familiar with how your business works. Developing the operating manual and keeping it up to date may require time, but it also helps you to save time - and money!
Developing the business step by step
This sub-chapter should assist you to identify and plan the necessary actions and investments in a timely way, so that you achieve the envisaged quantity and quality of products for sales.
What scale of production?
Defining the envisaged scale of the production is a crucial first step in planning the business. The scale of the production will determine the resources you require. Start small enough to be able to manage the operation and the financial risk involved, but large enough to reach sizable volumes in a reasonable time span. What volumes have you dealt with before? Is that kind of volume or twice that size the maximum that you can manage for the time being? In other words, is your plan realistic? Make sure that you do not produce or buy more than you can sell, but enough that you can satisfy the minimum volume of your first client. Do you envisage reaching a scale that involves 50, 500 or 5,000 farmers? Are you planning for 10, 100 or 1,000 tons of production per year? How many staff do you need to employ, and how much capital do you have to invest? What is the time span? Of course, the different parameters are closely interrelated. Make a plan for the next 3-5 years in which you estimate the number of farmers and their expected production (based on average acreage and yields). The planning tool in Annex "Production planning tool" can help you to plan these figures.
As reality is always different from the best prediction, it is wise to calculate an optimistic and a pessimistic scenario as well as what you actually expect to happen. This production plan is the basis for calculating costs, revenues and the break even point (see chapter "Financial planning and management"). You need to revise it every year, inserting the actual volumes and costs incurred.
Minimum economy of scale
Assume that you achieve a 15% export premium on a good quality, certified organic product. With an export volume of US$ 400,000 that means that you get US$ 60,000 above the normal value of the product. All the extra costs that you need to make to get certified, to find the market, etc. should be subtracted. In the case where: you need half of that money to pay the farmers a higher price than other local buyers, certification costs US$ 6,000 a year, your field staff costs US$ 7,500, the extra measures to keep the organic product separate from conventional US$ 3,500 and participation in the Biofach costs US$ 6,000 a year, you are left with a U$ 7,000 extra profit.
For a commodity like cotton or sesame, such an export value may be attained with, for example, a volume of 250 tons of the product. If each farmer on average produces 500 kilos and the capture rate is 50%, you will need to work with more than 1,000 farmers.
The time needed to set up an organic business
If you are not yet in business and start from scratch, expect to take 5-6 years for your organic business to be fully established. Even if you are converting an existing business to organic, or developing an organic division in a company, it will take usually 3-4 years until it is running smoothly. However, most investors and entrepreneurs expect their business to break even within three years. Introducing a new production method, crop or processing technology again requires considerable time, maybe 3 to 5 years, because most people involved need time to become familiar with the change, which usually happens through a trial and error process. Don't forget that the farmers also need to become familiar with the organic way of managing a farm, and need to trust that you will market their produce year after year. While they are having their first trial field experiences, you have to have made plans for the organisational structures.
Phases in developing the business
It is advisable to start small and fairly focused. Once you are able to handle a business on a small scale and if the market responds well, you can grow and/or diversify by adding components such as additional processing levels or other products. If you try to develop everything at the same time and on a large scale, you are very likely to fail. Growing rapidly because many farmers are eager to join can easily lead to a situation in which quality management and marketing are no longer ensured. Make a realistic plan for a period of 3 years to reach a first break-even point (it may actually become 4 or 5 years…). Only once you have reached this point, go for a next step of growth and diversification, which requires new investment. Most businesses go through phases of starting up, consolidation, expansion, and diversification (Table 2). This means that there is a continuous development.
Diversification or specialisation?
Being successful in a specific business field requires a certain degree of expertise and thus specialisation. You need to know the specific production and processing technology to achieve high quality, and you need to know the specific market for the product. Most businesses therefore focus on one or few products. It rarely happens that, for example, an organic coffee business also includes vanilla in their portfolio, or that cotton businesses also deal with cereals and pulses, even though these crops combine very well in the field. Some companies feel better off dealing with only one product.
On the other hand, diversification helps farmers to improve the farming system (rotation), to enhance food security and to reduce production risks (see chapter "Designing the organic procustion system"). It allows businesses to spread certification and management costs over different products, and reduces their vulnerability to market fluctuations. Diversified business operations allow more flexibility when reacting to the changing business environment. Diversification, however, also has its limits. Developing new crops and markets requires new investments and specific know-how. There is a risk that it distracts management capacity from the core business, and that you get into fields which are just not your “cup of tea".
Organic businesses should therefore weigh carefully the pros and cons of taking up diversification options or focusing on the existing product portfolio (Figure 12). An alternative is to collaborate with other companies that deal with some of the other products. An organisation of cotton producers in Burkina Faso, for example, collaborates for the quality control, collection, processing and marketing of shea nuts with a local company specialised in shea butter processing.
Financial planning and management
Finance is one of the most important elements in any business activity. Although it is usually not the most favourite aspect people like to deal with, financial planning and management is not something you should leave to an accountant. If you have a solid financial plan then a major part of the business planning process is done. Financial planning is the financial translation of the detailed activities and their financial requirement. It makes you aware of all the costs involved and allows assessment of whether and when your business will break even. It helps you to keep finances under control and avoid running out of cash. Your business needs to compete on price with others who can produce the same product and quality. You therefore need to operate your business in a cost efficient way, and to produce good quality for a low price of production. In order to assess and monitor your price competitiveness you need good insight in your total costs. Even if you are an existing enterprise that adds on an organic business line or replaces an existing activity, you need to calculate all costs of production and of doing business.
Types of costs
You can divide your costs into variable and fixed costs: Variable costs are expenditure that varies with the production volume. Variable costs increase when production increases, and fall when it decreases. Examples of variable costs include the purchase of raw materials, packaging, or labour directly involved in processing. For instance if for the production of 10 litres of pineapple juice you need 10 pineapples and 10 bottles, then for the production of 1000 litres of pineapple juice you need 1000 pineapples and 1000 bottles. The costs of the inputs go up in direct proportion to the volume of production.
Fixed costs are expenses that do not vary depending on your production volume. Examples of fixed costs are rent of premises, certification fees, depreciation costs of equipment, salaries of extension staff and management etc. Whether your production is 10 tons of cotton or 100 tons of cotton that year, the rent for the building you are hiring will be the same. In the case of pineapple juice; the machine you use for producing the juice will cost the same in depreciation whether you produce 100 litres or 10,000 litres.
Your variable costs go up gradually, while your fixed costs increase or decrease in steps, for example when you change your office building, buy new equipment or hire additional staff. Costs for extension, ICS and certification are semi-fixed/semi-variable costs; they are not directly linked with the output, but increase to some extent when more farmers are included. When the fixed costs are relatively high, it is especially important to look for maximum use of what those fixed costs stand for.
Cost price calculation
The cost price is the total of all variable and fixed costs divided by the number of produced units (e.g. per kg cocoa beans or per litre of sesame oil). Initially, when production volumes are still small, the cost price per unit is high. With growing volumes that support fixed costs, economies of scale bring your cost price down (Table 3) Examples of cost price calculations are given in Annex "Examples of cost price calculations".
It is especially important when you are planning a new business that you calculate the cost price. It is of course much easier for an existing business, involved in the conventional business of the same product, to work out the extra costs that come with the organic project.
During the planning phase, exact costs are not usually known and therefore need to be estimated. There are often costs which are not sufficiently anticipated; especially for logistics. It is therefore wise to include a certain contingency in your cash flow planning, and to build up sufficient reserves. It is very important to keep close track of what the real costs are and redo the calculation as soon as the first season is over. Businesses should update their cost price calculation every year, and it becomes a tool to improve the efficiency of the operation.
The sales margin is the difference between cost price and sales price. Each type of business has its own margin. The higher the investment and the risk, the higher the margin needs to be. Margins on processed products are usually higher than on raw materials. The margin is not simply profit in the sense of money put in somebody’s pocket; it is a safety net that helps a business to survive in bad times, and it is needed if a business is to grow. In organic value chains in developing countries a margin of 10-30% is quite common. This margin can not be expected in the first year, but only when the business is consolidated.
The break even point is the level of production and sales where total revenue of sales is equal or above total costs (variable and fixed). After determination of variable costs, fixed costs and selling price, you can easily determine the break even point of your operation. If you want to estimate the volume needed to reach break-even you can use the following formula:
Total fixed cost(sales price per unit – variable cost per unit) break-even volume
You should calculate the expected costs and revenues over a period of time to assess the profitability of your business (Table 4). In organic businesses you have a conversion period. Usually you cannot sell the product as certified organic during the first one or two years. At the same time you have all the costs of putting field staff in place, an ICS, certification, and you probably have to pay the farmers some premium to motivate them. This means that the first two years are almost always a period in which you make a loss.
Once you are able to sell certified organic product, the situation looks better. However, often you will have expanded from the initial producer base to a larger one, which requires additional resources for extension, ICS and certification. First time marketing costs may also be higher than in a consolidated situation. In the third or fourth year, when you are able to sell larger volumes of your product as certified organic you should be approaching the break even point. Most organic businesses turn profitable within 3-5 years. The length of the conversion period, the complexity and the overall size of the business are the major determining factors (see chapter "Organic Business Guide", The time needed to set up an organic business).
In the following years you try to make the business more efficient, by optimising your cost price and marketing approach. This is when you start earning money. However, when reaching the initial break even point, you should already start thinking of adding another product or investing in scaling up your operation (Figure 13).
Cost calculations are normally based on real costs (existing business) or assumptions (start-up business). It is good also to analyse what happens when one or more of the factors changes considerably. This could be positive or negative changes. Typical changes are fluctuations in the currency exchange rate, but also higher or lower yields or changing market demand. A shortage of the crop may increase local prices above what you have planned to be the organic premium price. Increases in cost of diesel and energy have surprised many businesses in the recent past, so if you want to reduce your risks, you need to make a sensitivity analysis. This means that besides the normal case you calculate a best and worse case scenario. Table 5 provides an example of a sensitivity analysis. It is unlikely that all these factors will change for the better or the worse at the same time. You can also calculate worst and best case scenarios for each single factor.
Cash flow management
For any business activity it is important to plan your financial needs in order not to have a working capital shortage at a crucial time in your production or trade process, which would block your business activities. Throughout the year there are significant changes in cash flow. The best way to get insight into your financial needs is by planning your incoming and outgoing cash flow on a monthly basis (Table 6). You have to pay your office staff and the field officers on a monthly basis. Some organic businesses provide their farmers with inputs, like seeds and organic fertiliser at the start of the season. It can be quite an investment and it may take 10 months before that money comes back on to your bank account. You normally need most cash to pay the producers upon delivery, while you will only receive payments from your clients quite some time later. You will need to bridge the period between expenditures and revenues, for which you require extra working capital. By planning your cash flow on a monthly basis you can determine how much ‘foreign’ capital you need, and for how long. As money is expensive (interest) the smaller that amount and the shorter you need it for, the better. Cash flow predictions, like the one provided in Table 6, are also used to request a trade loan from a bank (see chapter "Financing your organic business").
A cash flow plan deals with incoming and outgoing payments and not with revenues and costs. For instance depreciation of a car is a cost but not an actual payment. It will therefore not appear on your cash flow planning, but will appear on your profit & loss account. When planning your cash flow always ask yourself if the items you are budgeting lead to an actual change in your cash or bank position in that month.
Figure 14 shows the liquidity situation of an organic vegetable production unit prior to getting external finance. They export during part of the year with weekly shipments. This means that the money comes back fairly regularly and the liquidity requirement is not high. Nevertheless, they need financing for their cash flow for the first 6 months.
Financing your organic business
There are not many companies that have sufficient working capital on their own to completely finance their business by themselves. Some people say that the success of a good entrepreneur depends on how good a banker s/he is. A producer organisation or enterprise will need capital generally for the following purposes:
- Investments (buildings, trucks, motor bikes, furniture, computers, processing equipment etc.)
- Working capital (payment of personnel, running cost of the business, inputs)
- Trade finance for buying of harvest
- Capital to overcome start-up losses
There a many different ways to attract or generate capital for these purposes, and most businesses use a mix of them. Possible sources of finance are:
- equity (own capital)
- loans from family and friends
- product provided on credit by the farmers
- advance payment by your client
- loan from a financial institution
Equity (own capital) Your own capital is the most dependable source of capital because you have full control over it and there are no costs attached to it. There are different ways of generating equity:
- Financial reserves built up through profits from previous seasons. These have to be well guarded until the funds are needed.
- Member equity: Most cooperatives ask their members to pay a fee when becoming a member. It can be in the form of product. This fee will be registered in the name of the member depositing it as equity of the cooperative. The membership entitles him/her to a share in the profit of the cooperative, unless the general assembly decides to keep the money in the cooperative. Profit can be paid out based on the value of the share, or based on the volume of product that the member delivered to the cooperative. Proper provisions need to be in place in case a member dies, or wishes to leave. The advantage of member equity is that it creates commitment of the producers towards their cooperative. It will also mean that they will want influence in the decision making in the cooperative.
- Share capital: If you are not a cooperative but an enterprise you can look for external investors willing to invest in your company. By issuing shares to them in exchange for their investment you give them part of the ownership in your company. Usually you have to convince them through a business plan. There should be rules on profit sharing among the shareholders, and about the influence that share holders can have in the company strategy or management. Investors can have a positive influence on your company, as they are often seasoned business people. Another example is the main importer of your product. There are even funds stimulating this, like the Private Sector Investment Programme in the Netherlandsy. There are also venture capitalists who wish to invest in promising businesses in the so-called emerging markets, and financing institutions focusing on sustainable investments.
Loans from family or friends
Many entrepreneurs have family abroad, or friends who have done well. For smaller amounts it is quite common to obtain a loan from family or friends, especially one that is paid back fairly quickly, with a profit. These are often informal loans that are not even put on paper. When it concerns larger sums of money, it is very likely that the person will want to have guarantees. They may become a shareholder in the company, so that the loan turns into equity. Whether family or friend, the relationship may come under stress when things do not go as planned, or when the lender wants his/her money back while you still need it. It is up to you how much risk you want to take to sacrifice friendly relations for your business purposes.
Product provided by farmers on credit
The biggest bottleneck in financing is the one of trade finance, needed to buy the product from the farmers, until you get paid by your buyer. In some cases it is a matter of six weeks before the payment comes in, in other cases this takes 3-4 months. Businesses therefore may try to ask the farmers to provide their produce on credit, in exchange for a document stating the quantity delivered. This type of credit system often goes wrong and most farmers prefer to sell cash in hand to the best possible buyer. Asking the farmers to deliver their produce without immediate payment is a situation that you should try to avoid.
Advance payment by clients
Certainly in more advanced relationships the buyer is often willing to pre-finance part of the trade contract. It can be part of the sales agreement and of the price negotiation. For them it is an assurance that they will get the product. They may be able to get trade finance for a much lower interest rate than you would need to pay. The condition for this is that the buyer trusts you. This trust is usually built over the years; it won’t happen in the first year. While the buyer may trust you, his/her accountant or bank will still insist on maximum guarantees. This usually starts with an exclusive trade agreement - otherwise you might be buying the product with his/her money and selling it to a competitor.
It might also mean that an external agency must be contracted to monitor how much product is in your warehouse. There may even be a construction with a kind of bonded warehouse. This means that all product that you bring in is registered and additional funds are paid out based on that collateral, and product can only leave the warehouse in a sealed container with the buyer as addressee. The moment that the container leaves, the real payment is effected by your bank. Then the money is really yours. These contracts are usually made for a specific amount of produce and with a tight time schedule. Once that contract is fulfilled you are free to sell the remainder to any other party. Be aware that such pre-finance might limit you in your freedom to sell to other buyers. It might however be a good solution if banks consider your business as too risky to provide a loan, or if attracting pre-finance from your buyer is a lot cheaper then a bank loan. Always check the different options that are open to you, and compare the pro’s and con’s of each option.
Loan from a financial institution
Taking a loan from a financial institution has a cost, and bears some risk. You need to pay interest and possibly pledge collateral. If the loan is taken in foreign currency, there also is the risk that the exchange rate changes to your disadvantage. Start-up businesses usually only get part of the required finance; the banks will always ask you to provide a significant part of the total sum required yourself. No one is going to put their money in your business if you do not invest yourself. One can distinguish two types of loans: trade finance and investment finance.
- Trade Finance: A short-term working capital loan (usually 4 to 8 months), mainly used for buying the raw product from the producers. In order to become eligible for trade finance you usually need a contract or a letter of intent of a buyer of your product. The buyer of the product has to be trustworthy enough for the financial institution as well, as often the loan is repaid through the buyer to the bank.
- Bank Overdraft Facility: Once you have built a good relationship with your local bank it might also be possible to negotiate a short-term overdraft facility on your bank account. An overdraft facility is to be used only for short term capital needs.
- Long term loans: For long term investments, such as machinery, a building or a truck, or to cover start-up losses, a long term loan is needed since you will need more than one season to recover the costs of the investment. In order to become eligible for a long term loan, a financial institution will look at your business plan, your financial and sales track record, possible collateral, and your equity/debt ratio etc.
For start up producer organisations or enterprises it is difficult to access external loans because of the lack of a long term relationship with a client, the absence of a financial or trade track record, the absence of collateral or other securities and the absence of equity. A guarantor could be the solution in this case. A third party who really believes in the future of your organisation or enterprise and who is financially healthy itself can partially diminish the risk for the lender, by issuing for instance a 50% guarantee to the loan.
Check with local banks and micro-finance institutions whether they can offer you credit for your organic business on reasonable conditions. If they can not, it is a good idea to also consider international financing institutions specialized in providing trade finance or long-term loans to organic and Fair Trade businesses (see list in Annex "Financing institutions providing loans for organic and Fair Trade businesses").
The last possible source of finance is a grant by a third party, such as development organisations or government economic development schemes. A grant could be given in the form of a seed capital grant. A seed capital grant will be integrated in the balance sheet of your organisation as donated equity. The advantage of a seed capital grant is that it improves your equity position through which access to external capital in the future becomes more feasible. There are also schemes that provide grants within a public-private development partnership, or assign a grant for the capacity building of your staff (see chapter Organic_Business_Guide/Roles_for_facilitators,_governments_and_donors#What_role_for_donors_and_development_agencies.3F|"What role for donors and development agencies" and Annex "Donors and development agencies supporting organic value chains").
The issuing of grants to start up companies is a last resort, because they may distort competition with market actors. Grants do not necessarily stimulate commitment of the grant receiver. In general, it is advisable to use your own funds and being cost efficient by ensuring good financial management. However, especially in a situation where a new business supports smallholders who otherwise have little chance in a market economy, grants can be justified.
Keeping the business going
Keeping an overview
An organic business rapidly becomes complex and so it is not always easy to keep a good overview. The management needs to know how key business parameters evolve in order to be able to take the right decisions. A reliable accounting system clearly is a must. Regular staff meetings help to keep everyone up to date, and to decide about how to deal with upcoming problems in a team spirit.
Keeping an overview also means knowing where the business actually stands concerning its key figures. It means being able to answer questions like: What acreage is under organic cultivation this year, and what is the expected production? How many farmers have already been inspected by the ICS, and how many were excluded from the project due to non-compliance with the standards? How much produce has already been sold, and how much is still in stock? What volume of seeds is required for the next season, and how much money to purchase the harvest from the farmers?
As your production is spread over hundreds or thousands of farmers, answering these questions usually requires summing up the respective figures of each farm. A database will help you to handle production and ICS figures in an effective and transparent way (see chapter "traceability and data management"). Similarly, your processing and sales figures should be entered in some kind of database. An Excel file can do the job until the business reaches a certain size and complexity that a more sophisticated system is required. The database also helps you to calculate and monitor key indicators of your business such as average yields, the ratio between extension staff and farmers, the realised margin between buying and selling, or the additional income generated at the level of the farmer.
In an organic business, many activities that are interlinked need to be orchestrated over the year. Farmers need to be registered and trained at the beginning of the season, harvest estimates need to be done at certain points of time, internal inspections need to be completed before the harvests start, logistics need to be arranged etc. Operational plans (see example in Annex "Annual operational plan") in which the different activities are listed with their respective period of implementation help you not to miss an important activity, and to plan activities that are interdependent. It is also a useful tool for monitoring and steering.
Annual review of plans versus realisation
You may plan your business with utmost care and sincerity, but reality almost always turns out differently. It is therefore important to compare your plan with the actual results at the end of each season, and to analyse the differences. This is true for production and sales figures, but also for the overall budget. Get the real expenditure out of your book-keeping, and adapt the budget for the next season accordingly.
Check real cost prices at the end of the season and see what costs you did not budget correctly. Analyse cost drivers and identify ways to save costs. However, there are also points where it does not pay off to cut costs: quality management and quality certification services, postponing payments or premiums to farmers, payment of field staff etc. Annual reviews also help you to optimise the performance of your business. It is a good idea to involve your team in this exercise, for example by discussing jointly the strengths and weaknesses observed during the last season. Evaluate how you could possibly become more efficient. Develop strategies on how to earn more, and how to reach the optimum size for your business.
Running an organic business involves certain operational, financial and market risks (Table 7). Doing business means taking risks; knowing and managing risks. Realistic planning is needed, which takes into consideration that effective volumes may turn out to be lower, costs higher and markets less responsive than one had hoped. Table 7 outlines some ways in which these risks can be mitigated to some extent. A simple rule of thumb says: The higher the risk you take, the higher margin you need to obtain.
Price risk management
Most entrepreneurs have orders or contracts fixed before the season starts. Within the order, the price can either be fixed or kept open. You may want to be sure that you are in the business for a certain volume, but if you have fixed the price far ahead of the actual buying, both can gain or lose from movements in the market or the exchange rate. Some entrepreneurs seem to wait for the best possible price; they are in fact speculators. Very seldom do they actually get the best possible price and often they don’t stay long in the market. They may not only harm the producers they buy from, but also disturb the wider organic market for the respective product. It is a much better policy to be content with a fair reward for your effort; you won't get this by taking great risks.
Entrepreneurs have to estimate the price they will buy at, and the price they will sell at. Local and world market situations change and exchange rates fluctuate too. This can be positive or negative; it is a risk. The risk is limited if you sell ‘back to back’. This means that you only buy for a certain farm gate price when you have a contract in your pocket for a certain sales price. The order is to buy 200 tons, possibly 250, and buyer and seller are in weekly contact, discuss and agree what will be the best time to fulfil the order. You ‘lock’ the price, the next week you buy.
However, most businesses dealing with non-perishable products do not only sell during the harvesting season. You have to buy produce that you keep in stock for delivery later in the year. You can either go “short” (you have contracts to deliver for more than you possess), or go “long” (you have more in stock than you have sold). It is very dangerous to commit yourself to sell more than you have in stock; you may even lose your buyers. On the other hand, if you want to expand, and you expect more orders to come in you may decide to go long. In both cases you are playing with fire! One major strategy for limiting your risk is to limit the volume by which you are long or short.
Management structures and capacity
Organic enterprises often start as a very small structure, possibly even as a one-man or one-woman show. Even when hiring staff, many entrepreneurs stick to taking all the decisions themselves. Producer cooperatives on the other side tend to involve a large number of people in decision making. This can block the development of the business. In both cases, the top management needs to be willing to delegate responsibility to ‘middle management’. Whether an entrepreneur or a cooperative governing body is able to delegate responsibilities will determine whether the business moves from small to medium size.
Efficient management structures
Management structures need to be designed in such a way that decisions can be taken in an informed and timely way, and at the same time ensure that the people involved in the business feel that their views are taken into consideration. Farmer cooperatives tend to keep a lot of decision power with the general assembly and the board of directors they elect. Decisions sometimes need to be taken in a very short time in order to make use of an opportunity, or to avoid failing to meet a contract. The executive director and the sales manager therefore need to have sufficient mandate to decide on most operational matters. When every decision, every bank draft needs to be signed by a hoard of people, it does not reflect well on your coop. On the other side the management structure needs to ensure that the executive forces report back to the governing body in a transparent and accountable way. The governing body needs to ensure that the business is managed in line with its core principles, and that there is no fraud or corruption involved.
Being professional means being both honest and trustworthy. Commit only to what you can live up to, and stick to your commitments. The market is small; you will be surprised by how much information is exchanged between traders who are in competition with each. When assisting existing businesses in looking for new markets it is not uncommon to hear ‘Oh no, not that one, thanks!” or similar. It is very difficult to turn such an image around.
Your clients expect you to be professional. That means that you have to have, or move towards having, a good administration, a functioning membership or shareholder system, checks and balances in place, accounts annually audited by a reputable organisation, and goods delivered on time at the same quality as the sample
The professionalism of your business should also be reflected in the way you present yourself: your printed materials and website, your business communication, and the way you interact with clients.
Developing management capacity
Running a business requires a set of skills and abilities that can not easily be developed on your own. An executive director of an organic business needs to have an entrepreneurial mind set and the ability to sell, but at the same time needs to be able to understand the situation of the farmers. He or she needs to be able to handle and understand budgets and business figures, but also to recruit and guide staff, and interact with the outside world.
When the business expands, new management capacities are needed. Running a small family business requires different skills and experiences from running a company involving thousands of farmers. Make sure you develop these capacities whilst growing the business, or hire the right staff with the necessary experience, and delegate tasks.
Criteria for successful entrepreneurs or managers in organic business:
- Open minded, flexible, determined
- Able to listen, willing to learn
- Good in keeping an overview of the finances
- Good communicators
- Sense the market, react to changing requirements, innovative
- Good business managers, organisers
There are various ways to build and improve your management capacities and these of your staff:
- Attend management training
- Get coached by an experienced person
- Make use of business development services
- Exchange with peers in other companies
- Exposure to other businesses, participation in networks
- Self-reflective "learning by doing"
Summary of recommendations
- Even if you do not write a fully-fledged business plan, you need to have fairly clear ideas on the main elements of your business strategy (organisation, scale, markets, costs and revenues, finance etc.).
- If you get assistance in writing a business plan, make sure that you and your team understand and support what is written in it. The process of developing a business plan is usually more important than the document itself.
- Keep the organisational structure of your business slim, simple and efficient. Define clear responsibilities for the main processes, and write them down.
- Start small and focused enough to be able to manage the operation and the financial risk involved, but large enough to reach sizable volumes in a reasonable time span.
- Plan your business in phases; expand and diversify after having reached a first break-even point.
- As a certain degree of specialisation is needed in order to be successful, carefully weigh the advantages and disadvantages of diversifying your business.
- Calculate expected costs and revenues over a period of time in order to assess whether your business can eventually break even.
- Make sure that you do not temporarily run out of money during the course of the year. Plan your cash flow in advance, and organise finance in time, if needed.
- Make sure that you have reliable and up to date figures at hand that provide you an overview of the core aspects of your business.
- At the end of the season or year, check the effective results with the plans. Analyse cost drivers and evaluate how your business can become more efficient.
- Limit your entrepreneurial risk by buying from farmers only at a certain farm-gate price if you have the respective sales contracts for most of this volume.
- Make sure that the people in charge of managing your business have the necessary skills and experience.