Maintain your working capital – that’s a given. But how much working capital will you need? Ag economists Michael Boehlje, Michael Langemeier and Ken Foster addressed this question in the December 2015 Purdue Agricultural Economics Report.
“The answer to this question depends on both the risk and size characteristics of the business, and the volatility of the business climate,” they note.
For example, a 15% to 25% buffer is often recommended (working capital that is 15% to 25% of total expense or gross revenue), but higher volatility means a higher buffer may be needed. When margins are negative, the burn rate of working capital can quickly accelerate.
“Lenders today are increasingly concerned about the burn rate on working capital,” the Purdue economists note. “Given the expected losses, even those who currently have strong working capital positions might find it deteriorating quickly over the next couple of years.”
Because of that, some experts say the working capital buffer needs to be as high as 35%, given margin pressures and increased uncertainty.
So what can farmers do in the current economic climate? The first thing to do is maintain an adequate portion of your asset base that you can easily convert to cash, the economists recommend.
“One of the easiest ways to manage working capital is to protect cash,” they note.
When you sell grain, that money can be kept as cash, used for inputs or used to purchase machinery or other capital items, or withdrawn from the business. Although there will be specific instances when it will be necessary to purchase assets or withdraw cash, keep close track of these instances because they can have a big effect on financial liquidity, they say.
Repayment schedule on debt can also have a big impact on working capital.
“If adequate collateral is available, the debt might be restructured with some of the operating line added to the term debt so that it can be repaid over more years, thus reducing current debt obligations and increasing working capital,” they say.
Finally, revisit capital assets that are not mission critical to the business, such as a vacation home, or even less productive land or excess machinery.
“This strategy is often not the first strategy pursued, but in situations in which cash is relatively short, it should not be excluded from the toolbox,” they admit.
To learn how several farmers developed strategies to manage working capital, go to www.agweb.com/top-producer/article/survival-of-the-realist-naa-anna-lisa-laca/.