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Improve working capital
To say that 2012 was challenging for hog producers is an understatement. As president-elect of the Illinois Pork Producers Council, Todd Dail knows that well. “If you're a hog producer and you buy feed, it was not a good year,” says Todd, who with his wife, Rebecca, runs an independent 10,000-pig farrow-to-finish business near Erie, Illinois.
The Dails farm with Todd's father, Max, who runs the crop-production side of the business. Located in the northern part of the state, in the Rock River Valley, the farm escaped the worst of the drought. Its corn yields ranged from about 133 bushels an acre to 202 bushels, with an average of 164 bushels.
“We have bottom ground and we have hill ground. The hog manure makes it all work,” he says.
When he can, Todd locks in profitable margins on the finishing hogs by using a brokerage service, Commodity and Ingredient Hedging, that tracks historical strength of margins.
So with a decent bottom line at the end of 2012, the Dails are joining other producers in building up working capital to weather even tougher times that may lie ahead.
Working capital is essentially cash, or assets that can easily be converted to cash. According to the Illinois Farm Business Farm Management Association, a ratio of working capital to value of farm production “is a measure of the amount of funds available for use if you sold all current assets and paid all current liabilities.” At the end of 2011, the median ratio for 2,511 farms in the association's study was .60, or 60% of a year's accrual revenue.
How much and where to save it?
That ratio is even more conservative than the 30% to 50% that lenders and financial advisers have targeted. The Dails' own goal is even higher.
“I would like to be more than 100%,” Todd says. “ I would like to be 150%.” He hasn't reached that number yet and his financial adviser hasn't suggested it. But it seems like a worthy goal. “The hog cycles are out there,” he says.
Having enough in reserve to pay bills and loan installments for a year or 18 months would help the Dails withstand an unprofitable downturn.
Another conundrum is where to put cash when savings accounts and certificates of deposit pay almost nothing (0.05% for a short-term standard CD at Wells Fargo at the end of 2012, for example). You can do better with online banks or interest-paying checking accounts, but checking account interest rates can quickly be reduced.
The Dails have found a slightly higher-return alternative through their lender, 1st Farm Credit Services. It offers a Funds Held Program that allows them to make advance payments, reducing interest and, in effect, getting a return of about 2%.
Todd explains how it can work, using a hypothetical example from his 10-year, $480,000 note for hog buildings. It charges the farm a fixed interest rate of 3.95%. He could put all $480,000 he owes into the Funds Held Program and, instead of paying it off, he's paid 1.95% interest. Because the loan accrues interest at 3.95%, “it's costing me 2% to park my money there,” he says. In essence, he has lowered his interest rate to about 2%.
He can pull out any money in excess of loan payments.
“Whatever I need it for — to buy feed, to buy pigs — the money is available,” he says.
Unlike a lower-paying bank savings account, there is no Federal Deposit Insurance Corporation to protect that $480,000 he can park with 1st Farm Credit Services.
“It's not insured, but I have debt against it. If something happens, my buildings will be free and clear,” he says.
Other farm credit lenders also offer ways to earn interest.
Farm Credit Services of America, which serves Iowa, Nebraska, South Dakota, and Wyoming, allows its borrowers to overpay operating loans and draw interest, with a program called CashPlus.
“It is an opportunity for our producers who've paid their credit line down to zero to have the excess swept into an account that is basically an investment in AgriBank,” says Craig Kinnison, senior vice president and chief financial officer for FCSAmerica.
AgriBank funds FCSAmerica, by selling bonds to investors through the Federal Farm Credit Banks Funding Corporation. CashPlus is not an investment in Farm Credit System bonds, which the banks cannot pressure borrowers into buying. Instead, “technically, it's an investment in AgriBank,” which is an entity rated AA-, Kinnison says.
At press time, CashPlus was paying 15 basis points, or 0.15%, a low return due to the Federal Reserve's efforts to drive down interest rates. “It does vary, but it's been there for a while,” Kinnison says.
In recent years, the liquidity of nearly 6,000 farms that belong to the Illinois FBFM Association has been improving, says Dwight Raab, who heads the 60-person staff that provides record keeping, financial management, business planning, and tax services to farmer members.
“We've been in an era of prices going up,” he says. On grain farms, unpriced grain can be a big chunk of working capital, which is measured in several ways. Working capital is what's left after subtracting current liabilities (bills and debts you expect to pay in one year) from current assets (what you can convert to cash in a year). Illinois FBFM calculates that at year's end. At the end of 2011, unsold corn was valued at $5.74 a bushel. At the end of 2012, it was valued at over $7.
A second measure of liquidity, the current ratio, divides current assets by liabilities. A ratio of 1:1 means you have just enough to pay off current liabilities. In the Illinois FBFM Association, grain farmers had the highest ratio, 2.73, at the end of 2011. Any ratio over 2 is considered a strong financial position, Raab says.
“We think it's important to look at your current ratio over five years,” Raab says. “Five years of current ratios can tell volumes.”
The third measure is the ratio of working capital to the value of farm production. (See chart above.) A ratio of 1 means there's enough working capital to equal a year's accrual revenue from a farm.
As the table shows, the ratio varies by farm type. Grain farms have the highest median ratio; dairy farms have the lowest. As you might expect, older farmers and those who own more than 75% of their land have higher ratios. Farms with higher revenue have a lower ratio, with those over $1 million having a median ratio of .51.
How to use working capital boils down to what each farmer sees as its most efficient use, Raab says. With the value of those assets constantly changing in the marketplace, there's some luck, too.
“I've run the numbers, and if I had to buy all of our corn,” Todd begins and Rebecca continues, “then we wouldn't be using Funds Held.”