Watching your liquidity levels - preparing for 2014
As we prepare for closing out our records for 2013, we have plans in place for 2014 and know that it will likely bring us lower profit margins. Several factors are working in the farm economy to erode our working capital positions that began to build with the advent of the renewable fuels standard that was a result of the Energy Policy Act of 2005. It isn't difficult to envision $200 less per acre in revenue in 2014. Budgets created by Gary Schnitkey for central Illinois higher productivity soils show a $548 operator and land return as recent as 2012. That same operator and land return had eroded to $409 for 2013 and is estimated at $378 for 2014. As your review your end-of-year financial statements note the trends in the amount of liquidity in your operation over the past few years as you look to keep a close watch on that liquidity in 2014.
Working Capital is the financial cushion that represents your operations ability to weather financial difficulty. It's like a full tank of diesel in the truck without a refueling point in sight. As long as you have enough you don't worry about it. When the fuel gauge starts to point to 'E' and there isn't a truck stop in sight...you begin to worry a bit. Thus, the stronger your working capital, the longer you can experience low profitability or even losses before 're-fueling' is necessary. The strong returns of the past five to seven years have done much to 're-fuel' the collective liquidity tank of production agriculture.
Capital purchases have affected our working capital. The IRS Code Section 179 Expense Election and Bonus Depreciation may have assisted in lowering your tax liability for the past few years, but that may have come at the expense of decreasing your working capital. Now, would be a good time to create a capital budget for the next five years so that you get the most 'mileage' out of your working capital over a period where margins could be thin.
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. Working Capital to Value of Farm Production 'marries' the balance sheet (working capital) to the income statement (VFP) to arrive at a ratio that makes your liquidity position relative to the size of the farming operation. The higher the WC/VFP ratio, the more liquidity the farm operation has to meet obligations. WC/VFP varies by farm type, farm revenue, age of the farm operator, and tenure.
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