Working capital still important in agricultural finance

We often hear phrases like “protect your working capital” or “watch your cash flow” or “money is king” in reference to the short-term financial analysis of a farming business.

All of these terms generally refer to the “working capital” of a farming business. Many grain farmers in the Upper Midwest are coming out of a fairly profitable year in 2021 and have more excess cash to spend on the farm. While it can be tempting to spend all the extra dollars that are available on capital investments for the farm or for non-farming purposes, it’s a good idea to continue to focus on working capital for a farming business. Many farmers have seen their farm working capital drop significantly from 2017 to 2019, so there is a need to rebuild it in the future.

The simple definition of working capital is total current assets minus total current liabilities. While this definition sounds straightforward enough, getting true and accurate working capital data can be much more complex in many situations. Current assets generally include cash available in bank accounts, accounts receivable, grain and livestock inventories, prepaid crop and livestock expenses, hedge account balances, and any other outstanding assets. short term. Accounts receivable can include payments from crop insurance or government farm programs, deferred payments on grain or livestock that have already been sold and delivered, and money owed to a farm for custom or contract work. contract.

Current liabilities include all accounts payable, unpaid taxes owed, all loans of agricultural inputs from cooperatives or seed companies, the principal balance of farm loans, and accrued interest on all loans. Current liabilities also include the amount of loan principal repayments due over the next 12 months (not the entire principal balance) on all term loans and mortgage loans.

In the case of grains that have been on a nine-month CCC loan from the agricultural service agency, either the full value of the grain should be shown as an asset and the loan amount as a liability, or simply the estimated net worth of the grain should be listed as an asset.

The financial ratio that is often used to express the level of working capital is the “current ratio,” which is simply the current assets divided by the current liabilities. A current ratio of 1.7 or more on a farm is generally considered quite strong, while a current ratio of less than 1.2 is usually a harbinger of potential financial challenges or cash flow difficulties in the business. agricultural exploitation. If the farm’s current ratio drops below 1, it probably means that it might be difficult to pay off all accounts payable at the end of the year, as well as pay off the entire principal balance of the loan. farm for the previous year. In more serious situations, it might also be difficult to pay all required installments on term loans and home loans.

Another ratio that many farm financial advisers and farm lenders follow very closely is the level of working capital to gross income of a farm operation, which more accurately reflects cash flow requirements based on the size of a farm. agricultural exploitation. This ratio divides the working capital calculated for the farm operation by the annual gross income of the farm business. For example, a farm operation with a calculated working capital of $ 200,000 and an annual gross income of $ 400,000 would have a ratio of 50%, which would be quite high. However, if a farm had gross income of $ 2 million with working capital of $ 200,000, the ratio would only be 10%, which could be a financial problem if not addressed.

A working capital-to-gross income ratio of 30% or more for agricultural operations and 20% or more for livestock operations is generally considered acceptable by most agricultural lenders. Many farmers strive to have working capital levels of 40% or more for cash flow purposes. If the ratio falls below 10%, this is usually an indicator of some financial stress in the farming business, which may require financial restructuring. If this happens, farmers should consult their farm lender to explore viable solutions.

Based on farm business management records for more than 1,500 farms in South and Midwestern Minnesota, the average ratio of “working capital to gross income” in 2020 was about 32%, which is an average. improvement over the previous five-year period (2015 to 2019). ). In 2020, farms had an average ratio of just over 40%, with most livestock and dairy farms at much lower levels. The data also showed that farms that were in the bottom 20% of net income in 2020 had an average ratio of only 12%, while farms in the top 20% of net farm income had an average ratio of more than 36%. There was very little difference in the average ratio between the different farm sizes which ranged from 500 acres to over 2,000 acres.

It should be noted that 2020 saw the highest level of government farm program payments on record, accounting for well over 50% of net farm income in 2020 for many farms, resulting in a noticeable improvement in fund levels. turnover for the year. The higher levels of working capital expected at the end of 2021 will more likely be based on improving profit margins for crop and animal production.

As we enter 2022, the level of working capital is expected to improve for farmers in many areas of the Upper Midwest; however, working capital can still be a concern for farms that have been affected by drought in 2021 and for some pastoralists. Farmers who have a large amount of term and real estate debt with sizable annual payments also need to focus more on maintaining a strong working capital. The much higher costs of fertilizers and other farm inputs for 2022 are also expected to impact working capital by the end of the year.

Once a farmer has identified the need to improve the working capital of the farm, he should consult with his farm lender and farm business management advisers to develop a workable plan. Here are some possible ways to improve the working capital of a farm:

• Use any additional cash income generated by the farm business to pay off accounts payable or reduce the farm operating line of credit, rather than making additional principal payments on term loans.
• Avoid spending excess farm cash on buying capital or land you don’t need, or adding unnecessary term loans with annual capital payments.
• Consider refinancing term loans and home loans for longer term financing to reduce annual principal repayment requirements. Long-term interest rates are currently still quite favorable.
• If the farm business loan is near the maximum capital level, or if the farm had a farm business debt carried over from the previous year, it may also be advisable to refinance a portion of the operating debt. agriculture with longer-term funding.
• Consider selling any unused or additional farm or personal assets, possibly including a piece of land, to generate additional cash to use as farm loan payments. Remember to factor in the tax payable when considering the sale of land or other assets.

In most situations, the lack of working capital occurs a year or two after very profitable years, as farmers tend to invest in higher priced capital investments and farmland, as well as use farm cash flow for non-farm purposes. Many times this involves adding more medium to long term debt that needs to be serviced on an annual basis which can lead to cash flow and working capital issues in the years to come. Most farm lenders and farm business management consultants are well prepared to help farm families put in place a manageable working capital strategy for their farm operations.

For more information, contact Kent Thiesse, Farm Management Analyst and Senior Vice President, MinnStar Bank, Lake Crystal, Minnesota, at 507-381-7960 or [email protected].