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Plug Leaks in Working Capital
Working capital in the ag sector has been steadily declining in recent years and is reaching critically low levels. That takes a painful toll on farmers and ranchers.
“The amount of working capital an operation has tells how much cash flow the business is providing,” says Tina Barrett, farm financial consultant with Nebraska Farm Business (NFB). “It affects the operation’s ability to pay bills within the next 12 months. As working capital declines, farm families are feeling the pinch. They may not have a lot of ability to pay expenses on time, so they may lean more on borrowed money. But that can only go so far.”
Working capital is the difference between current assets and current liabilities calculated annually at the same stage of the accounting cycle or production year. Farm business management analysts also look at working capital as a percentage of gross revenue.
On average, the 400 farmer-clients of NFB saw working capital as a percentage of gross revenue decline from 25% in 2017 to 21.5% in 2018. In 2013, it averaged 42% for those operations. Corn and soybean growers comprise the lion’s share of NFB’s client base.
Farm business analysts in Illinois see similar downward trends in working capital, though weather and other production-related differences related to geography also influence the degree of erosion in working capital.
“In 2012, our farmers averaged 50% of working capital as a percentage of gross revenue,” says Brad Zwilling, a farm business analyst with Illinois Farm Business Farm Management (FBFM). “But in the last three years, that ratio has dropped to just under 40%.”
The FBFM analysts work with 5,600 farms averaging about 1,200 acres. Most operations grow corn and soybeans.
Because working capital is tied to profitability, the biggest cause of the erosion of farmers’ working capital is, of course, the decline in commodity prices from their high point several years ago.
“But farmers’ expenses haven’t come down as fast as the price of corn,” says Zwilling. “So farmers are paying for high expenses with less income and higher interest rates. There’s not a lot of room for error.”
High family living costs compound the shortfall in cash. “When we had the run-up in price, we also had a run-up in family living costs,” he says. “But those family living costs are taking time to come down.”
How to Plug It
It is possible to plug the leaks and slow or stop the drain in working capital, says Barrett. “It can be done. We have clients who have working capital that’s about 80% of their gross revenue. They have enough working capital not to have to borrow operating loans. They know their cost of production and then manage those costs in order to operate profitably.”
Zwilling agrees that the leaks in working capital can be plugged. He offers the following six suggestions.
• Keep and analyze farm records. “Keep a balance sheet and accrual income statement,” he says. “These records show what’s going on in the operation.”
Maintain consistent annual starting and end points for farm records. For the purposes of figuring annual working capital, subtract the value of the year’s current liabilities from the value of the year’s current assets.
Current assets are those resources that can be converted into cash within the year. These include inventories of crops and market livestock, prepaid expenses, accounts receivable, savings accounts, hedging accounts, and stocks and bonds.
Current liabilities include annual operating notes, accounts payable to vendors, accrued payroll taxes, accrued real estate taxes, accrued interest on term debt for both farm and nonfarm loans, and annual loan payments for term debt. Also included in liabilities are accrued income and Social Security tax.
• Maximize the potential for profit. Look for potential profit in every acre, every cow, every nook and cranny of the operation. Cutting costs and spreading assets over a broad base of use could leverage less loss and perhaps even profit from individual enterprises.
“Maximize your dollar per acre and maximize assets,” says Zwilling. “Make sure you’re getting the most use out of equipment and other inputs. That could mean, for instance, providing the cow herd with the care they need to produce calves efficiently.”
• Hold money in cash. Building reserves of cash increases working capital, of course, and reduces dependency on operating debt. “In times of potentially tight profitability, don’t pay down long-term debt and don’t buy assets just to get a tax deduction,” says Zwilling. “As much as possible, hold money back to pay necessary current expenses.”
• Analyze use of assets. “Look at your assets to see if there are some things that you don’t need,” he says. “Maybe there is a piece of equipment you might sell and lease the machinery instead. The sale of the underutilized asset could increase the cash on hand.”
• Generate more revenue. Brainstorming ideas for side businesses, custom work you might do, or paid services you could provide for others could potentially increase working capital. Off-farm jobs fill the same role, as long as at least some of the money is set aside for working capital.
• Refinance. Zwilling views refinancing as a “one-time fix.” It’s a way to roll over short-term debt like operating notes and equipment purchases into existing long-term debt collateralized with land, for instance. “It creates a longer liability but frees up cash for working capital,” he says.
Barrett agrees that refinancing could be an option. “Refinancing is a reasonable answer for some operations,” she says. “But if you don’t know what caused the drain in working capital, it may be like putting a Band-Aid on a cut that needs stitches and could cause more problems down the road.”
Free Up Cash
inancing has a more positive use when a long-term loan can be secured by land or equipment initially purchased with cash when farm profitability was high, she adds.
Overall, plugging the drains in working capital begins by studying your operation to find ways to free up cash.
“We’re seeing farmers making some changes, analyzing records, and maximizing assets,” says Zwilling. “Some are cutting back on fertilizer and applying multiple times for better utilization. In general, they’re changing to methods that have a lower cost of production. They’re looking at ways to generate more revenue from assets. Some have bought equipment with a neighbor instead of owning it themselves; some have diversified.
“I believe farmers have the tools they need to find the best solution for their situation,” he says.