Hello and good day!
Long before I started doing marketing for our family business, I was only the company's Chief Financial Officer. I did that for a good 12 years before I ever wrote one of these daily emails. I have a master's degree in accounting and have been a finance nerd since college.
There are certain economic and financial aspects of how we do business that I've wanted to explain, because I find them fascinating, but I always think it will be too boring. My inclination is to lay out numbers and give a financial breakdown of what it all means. But I just don't think a full numerical breakdown can be done adequately in an email like this one.
So, I want to try something different. I am dead set on attempting this because it has big implications, and it may give somebody out there a business idea to pursue which could end up doing lot of good.
Our company buys cacao directly off of cacao trees. We pay cash on the barrel for freshly harvested cacao.
I will use a dollar for the cash outflow so that we have a good, easy round number to work with. We give the dollar to our cacao farm partner, and we get the seeds from inside the pod.
From the time that dollar is spent, it will be seven months until we get it back plus profit. It is the profit that allows us to pay ourselves and all of the people working for our company. As you can see, right off the bat, our cash is strung out and we are underwater, and we stay that way for at least 7 months.
In the beginning, the cash we used to pay cacao farmers came from savings that my father and brother had accumulated. My dad was older when the chocolate business started and instead of putting his money into a fixed income investment, he started buying cacao.
That was gutsy.
Now consider this. Let's say you lay out a dollar and in seven months, you get back one dollar and twenty cents. That's pretty good, because you made a 20% return in seven months. That beats the stock market.
By the way, these aren't real numbers for our business. I'm just using them to illustrate mechanics.
If you've publicly stated over and over again that you want as many cacao farmers as possible to join your project, you will very shortly face a problem. When you go back out into the jungle the next year, you will find that there is now a dollar sixty worth of cacao to buy.
Uh-oh. You made a 20% return, but you find yourself cash flow negative. Your dollar twenty is not enough to buy the dollar sixty worth of cacao available. You need all of your profits from the previous year, and you need to dig further into your savings, and you still haven't paid yourself.
If your business continues to grow at a rate that outstrips your capital accumulation, you can end up in the strangest of situations.
Highly profitable but deeply cash flow negative.
You have assets, but the assets aren't liquid, meaning they can't be converted quickly into cash. Instead of money in a checking account, you have cacao in a warehouse in the northern Peruvian jungle, or in a warehouse in the Swiss alps.
On paper, you have a net worth, same as if you have equity in a house. But you can't realize the net worth until you sell the asset. In our case, by the time we got around to realizing the worth of our assets, it was already time to reinvest.
It went on like that for a good long time until finally the growth in cacao production dipped below our return on capital, and then we started getting ahead on cash. Any small business owner with a self-funded inventory business can relate.
They are ways out of this scenario.
You can get a line of credit.Instead of using your savings, you borrow on the line and then when the profit comes through, you pay back the line. Of course, in this case you will pay interest on the line and that eats into your return.
Also, if for some reason you can't sell the asset, you are stuck with debt you can't pay back and that can have ugly consequences. Our family members has business bankruptcies in our past that have made us weary of going deeply into debt.
Another way around this is to take on investors. They give you a bunch of money in exchange for ownership in the company. You use investment funds to buy inventory and that way you don't have to use your personal savings.
This reduces risk, but you lose control...
One thing I've learned from discussions with venture capital firms is that they are always driving for an exit. They want to sell their shares at a profit as soon as possible.
This leads to several issues we aren't willing to deal with.
There will be an incessant drive for growth and profit maximization at all costs in order to boost the value of shares.
Our goal has always been top quality products and a model that benefits cacao farmers.We'd almost certainly be pressured to abandon this focus if we were to take on outside investors. Also, you can end up with a carousel of business partners. One venture firm sells to another, and that firm sells to another and so forth. Every few years, you have a new set of investors to deal with and manage.
The final way out of this is to add middlemen to a supply chain. This is a popular choice in many commodity markets and is especially prevalent in cacao.
Unfortunately, the inherent outcome of this solution is overpriced, poor quality products, and low prices paid to farm suppliers of raw goods.
Instead of buying the raw material and holding it for 7 months, we could hot potato the cacao and sell it off to somebody else as quickly as possible to make a quick profit. In fact, we could even set up a deal with our cacao farm partners to not pay them for seven days.
Then we could take cacao to the nearest big city and sell it to an aggregator. They'd pay us and then we'd go back to the farm and pay the farmer within the seven-day window and keep a markup.
In that case, we might make our full 20% in just seven days.
This makes adding middlemen to supply chains a very attractive option, especially if you are a middleman.
I'm running out of space for today.
I will continue with this exploration tomorrow.
Thank you so much for your time today.
I hope that you have a truly blessed day!
