Cash Burn or Cash Build

October 12, 2016 09:29 AM
 
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Financial liquidity can help you weather low grain prices—while minimizing the burn.

Steve Allard, Chief Credit Officer | Farm Credit Mid-America

The only thing certain about commodity cycles is that they’re uncertain, and farmers must have a plan in place to maintain the financial liquidity needed to plant and harvest an annual crop in good times or bad.

Given crop prices and production costs projected by the USDA for 2016, it appears many corn, soybean and wheat farmers will be operating at a cash flow deficit, or what is called cash burn. Because we’re coming off several prosperous years, cash burn rates haven’t been top of mind in quite some time.

However, understanding cash burn or cash build rates is important, as they indicate if you’ll enter the coming year in a position of strength or a position of challenge.

Determining an individual burn rate, and what a farmer needs to do to manage it, is an important exercise. Farmers can expect their lenders to want to have a good understanding of their working capital position and projected cash flow, including estimated crop yields and prices. Analyzing these variables along with individual fixed costs helps determine if the operation is in a cash build or cash burn situation. And in today’s environment, we’re finding that many farming operations are showing some level of cash burn.

In our work with customers, we’ve identified areas where they can minimize the impact of cash burn. By understanding fixed costs and outlining an approach to liquidity you can put yourself in a position to reduce the impact of low grain prices in the coming year.

Control fixed costs

Seed, fertilizer, fuel and other costs needed to produce a crop are categorized as variable costs. But farmers also need to understand their fixed costs, which can include land, buildings, equipment, employees, family living expenses and taxes. Fixed costs are costs that must be paid whether you put in a crop or not. After looking at thousands of customers’ financial data here at Farm Credit Mid-America, we see a lot of variance in farmers’ fixed costs. And it is a determining factor in whether the farming operation is in a cash burn or cash build mode. In fact, fixed costs are typically the one variable that separates high-cost and low-cost producers. And in this environment, it is especially important to be a low-cost producer. Recent actions taken by customers to manage fixed costs include terminating leases on marginally producing rental acres. Some are selling underutilized or non-critical assets. Others are renegotiating rental rates with landlords or critically analyzing any opportunities to buy additional land. Many are forgoing equipment purchases as can be attested by recently reduced profit forecasts of equipment manufacturers.

Rethink liquidity

In recent profitable years, many farmers paid cash for capital assets, including equipment and real estate. Or they made very large down payments and/or financed the balance on shorter than normal loan repayment terms. Those decisions appeared wise at the time but may now place additional strains on cash flow and liquidity.

Loan refinancing can have a direct, immediate and positive impact on your cash burn/cash build rate. Although a five to ten-year loan may have looked like a good way to finance a real estate purchase when grain prices were much higher, now those large loan payments in a low grain price environment can create a real challenge for cash flow.

We’re encouraging farmers to talk with us to make sure their loan structure and terms are right for today’s environment and their situation. Stretching loan terms out from five or ten years to a more typical 20-year amortization reduces the annual cash flow requirement to service the debt.

Line up financing now

One crucial tool for providing liquidity is an operating line of credit. We’ve seen less demand for operating lines in recent years due to historically high net farm incomes reducing farmers’ need for a line of credit. But that has also changed. And as soon as harvest wraps up, it’s important to begin thinking about securing an operating line of credit for 2017. The earlier those discussions start with your lender the better, as the additional time will help you and your lender better understand your needs in 2017 and beyond.

Typically, you are only charged for having a line of credit when money is taken out. But if the money stays where it is, no interest is paid on it. And even if the cash goes unused, a larger credit line offers confidence that you’ll have the financial resources to put in a crop this year. Liquidity offers flexibility to take advantage of opportunities, such as early-pay discounts on seed, crop protection chemicals or fertilizer.

Farm Credit is committed to being a reliable source of credit for customers in any economy. We advise you to always make borrowing and buying decisions based not only on opportunities, but also business need.

For additional financial tips, insights and perspectives, visit the Farm Credit Mid-America website.

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