The Farm CPA
Paul is now part of the fourth generation in America that is involved in farming and hopes the next generation will be involved also. Through his blog he provides analysis and insight to farmer tax questions.
Working Capital - Lifeblood of a Farm
Jun 21, 2010
Dave Kohl is an ag economist who writes the Road Warrior of Agriculture columns for Corn and Soybean Digest. His columns are usually very insightful regarding economic issues related to agriculture. Back in March, he had an article regarding working capital being the financial shock absorber for farms and business.
Working capital is the excess of a farm's current assets over its current liabilities. Current assets are your short-term liquid assets such as cash, crop inventories, and receivables for crops sold. Your current liabilities are what you owe on a short-term basis such as notes payable to banks, accounts payable, wages and taxes payable and your current portion of any long-term debt payments. Many farmers forget to include this item when doing their current ratio calculation.
It used to be that the current ratio was very important to calculate. This number is based upon taking your total current assets and dividing by your total current liabilities. If this ratio was about 2 or higher, it was considered very good; between 1 to 2 was marginal to good; and below 1 was bad. However, we are now stressing that your working capital to revenue is a much more important metric to measure and strive for.
The problem with the current ratio is that it does not indicate how much working capital is available to fund your farm operations. For example, assume your annual farm revenue is $1 million. Assume you have total current assets of $250,000 and current liabilities of $125,000. Your current ratio is 2 to 1, which is considered good; however, your working capital as a percentage of revenues is only 12.5%. This means that you would need to have the ability to borrow from a bank to fund current operations until you are able to harvest your crop and convert it to cash.
Based upon information from FINBIN, the top 20% of crop producers had working capital divided by gross farm revenue ranging from 28% to 43% in the past four years. The average producers ranged from about 20% to 33%, while the bottom 20% were in the low 20% range for these four years.
As more lenders use this metric in assessing farm operations, you need to know what yours is and what it should be. I would suggest that you strive for it to be at least 30% for most crop farm operations. Livestock operations would be about 5% to 10% lower.