It’s not like producers are printing money at the moment. Those who have been around agriculture long enough know it’s just a matter of time before the market turns and farm operations become profitable again. Along with profits come the prospects of having to decide what to do with your excess cash.
We first need to lay the ground work for what excess cash is. Bankers and borrowers alike have differing views of what excess cash really is. So, let me give you my very simple view: Excess cash is cash remaining at the end of the month after you have paid:
- recurring operating expenses
- reasonable family living expenses
- recurring capital maintenance costs
- regular interest and term loan payments
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Free cash flow is the cash that remains for discretionary purposes. It is at the borrower’s discretion what the excess cash will be used for. Experts in the Main Street business world tell you to store it, pull it, buy inventory, buy another business or spread the wealth among your most loyal employees. For example, before the dairy industry crash of 2009, producers often directed cash and borrowed money toward expansion projects—more cows, more freestalls, more modernization. Dairies and their bankers built assets. This is not necessarily a bad thing. But, when coupled with market volatility, timing is everything.
So what should you do with excess cash? There is a short and long answer to this question. If we continue our dairy illustration, the short-run answer is excess cash should be used to pay down herd and feed debt. Reduce your interest cost, build a store of working capital in your herd and feed, then decide what to do next.
Unless it is the only debt you have, it rarely makes sense to prepay long-term real estate and equipment debt. Prepayment of term debt ties up your cash through the maturity of the loan. Don’t forget, you operate in a volatile industry and the first line of defense against volatility is having access to your working capital when you need it most.
From a long-term perspective, you must decide how much of your working capital can be allocated to expansion and deferred maintenance or asset purchases. There is no magical formula here, and it depends where we are in agriculture’s profit cycle.
In the end, it’s all about planning. Plan your cash uses during the profitable times in preparation for the tough times that will surely come again.
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