Maintaining working capital for your farm operation
While facing tight or negative profit margins, I am continually asked what areas a farm operatorion should focus on. Although it has been said many times before, I can’t emphasize enough for farmers to become experts of their own farm financials, in particular analyzing their working capital position.
Some have been able to hold steady over the past few years, but very few have been able to grow their working capital. Over the last five years, we have seen a trend of declining working capital, not just grain operators but across most of the agriculture industry. None of this should come as a shock to anyone, but let’s break it down to help you better prepare for the months ahead.
Simply put, working capital is a measure of your “net” liquid assets on your farm’s balance sheet. Working capital is the liquid funds that a farm operation has available to meet short-term financial obligations. Using your farm’s balance sheet, it is the difference in value between current assets and current liabilities. Current assets are assets that can be turned into cash in one year or less and include cash, grain inventory, pre-paid inputs, and accounts receivables. Current liabilities are liabilities due within one year and include operating loans, accounts payable, current portion of term debt payments, and accrued interest. Working capital is calculated by subtracting current liabilities from current assets.
Working Capital is something that is closely looked at by Ag lenders, especially during times of volatility. Due in large part because it is a strong indicator of a farm’s ability to meet cashflow demands and manage future earnings volatility. By having strong working capital, you are able to position yourself to take advantage of unexpected opportunities, and make strategic investments in the business.
Typical underwriting guidelines require 15% working capital compared to your annual gross revenues. For an average grain operation this will be close to $100/acre of working capital. Although 15% working capital/revenue or $100/acre is what is preferred by lenders as a minimum, a good management target would be 30% working capital/revenue or $200/acre. According to Compeer Financial’s 2017 benchmarking report, the clients in the benchmark averaged $241/acre of working capital which is a decrease from the 2016 average at $258/acre. With the difficult outlook in the agriculture economy I would expect the average to decrease again in 2018.
Looking at who has been able to maintain working capital are those who are able to stay profitable. If your operation is losing money you will burn working capital in order to meet cash flow demands and keep all the bills paid. In order to maintain working capital, I would recommend that you limit all capital purchases unless absolutely necessary in these difficult times. If a capital purchase is necessary then I would strongly recommend financing the purchase in order to maintain as much working capital as possible.
We have seen some clients rebuilding their working capital through restructuring of debt and Compeer has done this for many of our clients. The key to this being an effective solution for your operation is to ensure that you are making other changes to your operation that will keep you profitable into the future. Otherwise the restructure is just a short term fix and soon you will be without working capital again and will have an increased debt load because of the additional real estate debt. Lenders typically only like to rebalance debt once so if you have to go back for a second rebalance to improve working capital it will likely be much more difficult to get approved and you may need to look at different options to rebuild working capital.
Although the idea of selling of assets can be a tough pill to swallow, it is a possible way to improve your farm’s working capital position. I would encourage you to look for any underutilized or unneeded equipment that could be sold to improve your cash position. Another option could be to sell a piece of land. Maybe there is an outlier farm or a less productive farm that wouldn’t have much effect on your net earnings if it were sold. You may want to consider selling that farm to improve your working capital and it may also improve your future earnings. As always when selling assets, be aware of potential tax implications.
I mentioned earlier, becoming an expert of your own financials should be a top a priority. The FINBIN or Farm Financial Management Database offered by the University of Minnesota is a great tool and resource for farmers to see how they stack up against their peers and has the potential to help farmers build reports to keep an eye on how their farm is performing year after year.
As we approach the end of another harvest season, I would encourage you to make sure that your current balance sheet is up to date so that you can determine your current working capital. If you are worried that you may run into issues, reach out to your financial lending partner. Maintaining open communication will allow them to work with you in being proactive and finding resolutions to potential problems, rather than be reactive after you find yourself in a tough spot.
Sean Mulcahey is a senior credit officer with Compeer Financial