“Cash is king,” but don’t let it become a cruel ruler
Working capital is a vital part of any farm operation. Especially in a year of tight margins, cash offers options. So the questions become how much do you need, and how can you generate more?
Purdue ag economists Michael Boehlje, Michael Langemeier and Ken Foster recently recommended farmers hold a buffer of 15% to 25% of total expense or gross revenue. That number can grow to as much as 35% if margins are negative and the burn rate of working capital quickly accelerates.
“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.”
How can farmers best manage their cash flow? According to Peter Martin, finance and growth consultant with K•Coe and Farm Journal columnist, there are several strategies to consider.
“There’s no magic bullet,” he says. “There’s no quick and easy way to generate cash.”
Martin’s first recommendation is to review cash flow on a weekly basis. That will help farmers identify problems more quickly and solve them before they become major pain points.
Start with grain bin inventory, he suggests. That can be a painful first stop when grain prices are so low.
“Sometimes you have to sacrifice some profits in the name of cash flow,” he says. “In fact, that’s one major reason retail companies have sales—to generate cash. They do it all the time. You, too, may have to put some things on sale from time to time.”
Another good way to free up cash flow is by practicing asset discipline, according to Ryan Bristle, Iowa farmer and business consultant with Russell Consulting Group.
“Maximize your equipment efficiency based on the number of acres you have,” he says.
There are no mathematical formulas to determine what exact equipment is needed based on total number of acres. Field size, labor and several other factors must be taken into account. But Bristle offers the following rule of thumb regarding equipment needs.
“In the Corn Belt, we often have a 20- to 25-day window of good weather to plant and harvest our crops and maximize yields,” he says. “Your equipment should be able to plant or harvest a minimum of 4% to 5% of your acres per day. That’s a good starting point for equipment efficiency.”
Do you have extra equipment assets that are underused or not used at all? Sell them, Bristle says. While that sounds like a no-brainer, he says many farmers have kept equipment they no longer need because their dealer didn’t give them enough on a trade-in, or they listed it for too much and it didn’t sell.
Used equipment prices are trending downward—good for buyers and bad for sellers, obviously. While older equipment might only fetch a few thousand dollars, Martin says, every bit counts—and it beats the alternative of equipment just taking up space in the machine shed.
“I’ve never had a client who didn’t have a piece of equipment sitting in the back corner they didn’t need,” he says.
Selling grain, equipment or even land often turns into an emotional decision, Martin admits. Find a trusted outside adviser who can help neutralize some of that emotion.
“It might be a bad deal, but it could get you through—don’t sell out completely just because you didn’t want to sell an asset here or there,” he says.
Managing leaner margins also gives farmers the chance to turn a potential liability into a new opportunity. “Turn lemons into lemonade,” says Scott Sartor, manager at K•Coe. “Get your operation really lean and liquidate items off the balance sheet you can’t turn into sales or revenue.”
When addressing your asset discipline, look beyond physical assets such as grain and machinery, Bristle advises. Restructure long-term debt by re-amortizing land mortgages or extending leases on equipment, for example.
Don’t turn down off-farm income opportunities. Even part-time or seasonal work can help increase cash flow. Keep working on tightening the off-farm budget, he adds.
“Unless off-farm income pays 100% of your living expenses, then your living expenses should be considered part of your farm expense,” he says.
Martin says now is the time to optimize your operation for future success. Get leaner and meaner, he says.
“You’ll be in such a better position when prices go back up,” he notes.
It’s good to always think one step ahead, Bristle adds. Farmers with a long-term plan tend to be more resilient, he says.
“Moving forward, remember what it’s like now the next time the cycle is strong, and plan for the long term,” Bristle says. “Plan for peaks and valleys, and keep trying to bullet-proof that balance sheet.”
What Are Farm Lenders Thinking About Right Now?
The Federal Agricultural Mortgage Corporation, more commonly known as Farmer Mac, began polling ag loan officers, managers and executives in 2014 to find out what’s on their minds. The survey led to a few interesting observations. For example:
- Their greatest concerns at the farm level are income and liquidity. This is especially true of grain and cattle producers.
- Interest rates will continue to rise and ag real estate values will continue to fall in 2016. Nearly half (47%) estimate land values will decline between 0% and 10%, with another 30% predicting they could slide by as much as 20%.
- Lenders are increasingly paying attention to burn rate. Currently, 38% evaluate working capital burn rate, and more than half evaluate working-capital-to-revenue ratios.
- Heading into 2016, it’s the first time since 2009 that farm equity is declining in both real and nominal terms.
- “In inflation-adjusted terms, farm debt is approaching levels seen in the 1980s, but relative to assets and income, leverage is still considerably lower,” according to the report. “Farm balance sheets are under pressure heading into 2016.”
- Net cash income—the amount of cash on hand to make debt payments, pay family expenses, invest on capital expenditures or save for future use—is expected to fall in 2016, but not quite as dramatically as it did in 2015.