Fiscal Fitness: Project Working Capital Needs

October 31, 2012 09:11 AM
Bob Matlick (resized) BlueWith Robert Matlick

Working capital. This two-word metric is rarely found in financial conversations regarding production dairy and dairy farmers.

By its simplest definition, working capital is current assets less current liabilities.

Bottom line: Working capital is the amount of readily available cash that a business has available to meet its operating needs and any unexpected volatility that is related to its business cycle. In the past, many dairy producers have relied on bank lines of credit for their working capital needs.

With increasing volatility in the milk output and feed input side of the dairy business, dairy owners should be keenly aware of their own personal working capital position. One of the most effective ways to accomplish this is to routinely forecast your business operations.

You will need to have a 12-month cash-flow projection that is measured by actual performance on a monthly basis. Each month, when the cash flow is updated with actual numbers, another month should be added to the end after reviewing the actual performance.

The cash flow should then be tested for sensitivity. This may sound difficult, but it simply entails working through several "what-ifs."

For example, what if the milk price drops by $4 per cwt.? What if feed cost increases by $2 per head per day? What if production falls by 8 lb. per cow per day?

It’s crucial to stress-test the main drivers of your cash flow. If your cash flow data is set up in an Excel format, the what-ifs can be changed easily and the effects identified quickly.

After a sensitivity test is accomplished (you will be amazed at the various scenarios you will become interested in), evaluate and identify negative cash flow positions that will occur within the 12-month time frame. The question then becomes: Does the operation have enough working capital to survive these negative projections?

Many producers have always relied on the bank to fund losses, should they occur. Others depend on trade vendors. However, as volatility has increased and margins have decreased, these types of fallback positions often do not prove to be reliable sources of working capital.

The dairy businessperson needs to identify and monitor his cash needs going into the future and plan for deficit cash flow while making certain there is adequate cash (working capital) to meet those needs.

The sale of operating assets cannot be considered to be readily available working capital, nor can extensions of trade credit.

I have been part of many discussions in the past year about whether operating bank debt may also be considered to be available working capital. Many have argued that only cash reserves or assets not associated with the day-to-day operation of the dairy and that can be converted to cash in a very short time frame can be considered to be working capital.

To my mind, bank lines of credit can certainly be considered to be available working capital if they are openly discussed with the lender at the annual renewal and given the lender’s assurance that valuation of the underlying collateral supporting the line will not change dramatically.

If a producer is going to depend on the bank for working capital, there should be open and honest communication when the loans are established and renewed. Otherwise, make sure the cash is around, because volatility is here to stay.

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