What should be your No. 1 priority for your balance sheet? “Working capital,” says David Kohl, professor emeritus of agricultural finance at Virginia Tech University.
Working capital is simply current assets minus current liabilities. But it’s also defined as the lifeblood of successful farming operations, Kohl says. Those with a strong working-capital position will be able to seize opportunities and withstand further economic headwinds.
The latest update the Economic Research Service (ERS) indicates the ag sector’s working capital has continued to decline and is now critically low. The forecast for 2019 is $38 billion. This is by far the lowest level seen since ERS started reporting the ratio in 2009.
“The declines in working capital are stark,” says Brent Gloy, an ag economist specializing in agricultural finance and agribusiness management with Ag Economic Insights. “It is projected to fall by 25% from 2018 to 2019. This is on the heels of a 30% decline from 2017 to 2018.”
Read Gloy’s recent Ag Economic Insights report: “Farm Sector Working Capital at Critical Levels”
Kohl encourages farmers to look at their working capital divided by total farm expenses. If that number is less than 10%, he says, it creates a vulnerable farm operations. He classifies operations with 10% to 33% as resilient and farmers with greater than 33% as agile.
A few ways to restock financial reserves, Kohl suggests, are to renegotiate cash rents, cut input costs, reduce family living expenses and diversify income streams.
By understanding the causes of working capital changes, farmers can gain vital insights on managing their farm business, according to experts at the University of Illinois. (See the farmdoc daily piece, “Minding Your Balance Sheet and Working Your Working Capital,” written by Bradley Zwilling, Brandy Biros and Dwight Raab).
The University of Illinois share these tips:
Prepare accurate balance sheets to know your position. In periods of declining prices, you must routinely compile an accurate balance sheet and accrual income statement. This will give you the knowledge to take action on pricing grain, selling assts, etc.
A drop in working capital can still be good for the business. A planned build-up of working capital over a period of year followed by a planned draw down of working capital could be the result of the planned acquisition of land or other assets.
It’s the unplanned drops in working capital that spell trouble. Now is not the time for a surprise spend of cash. Paying federal and state income tax is reasonable and is much better that spending working capital on depreciable capital asset purchases to solve a tax problem.
Understand the pros and cons of refinancing assets. Remember, refinancing does provide cash to improve your working capital but does not change your net worth. A refinance merely takes some of your intermediate-term or long-term net worth and turns it into current net worth. The obvious downside of refinancing term debt is that you are amortizing a short-term problem over a five-, seven- or even fifteen-year payback period.