By Jeff Schmidt, chief credit officer
This topic has been discussed in articles in farm periodicals and posts over the last few weeks, given the downturn that has occurred in different agricultural commodity markets the past year. Many producers will look at their unit’s equity position to assess their financial standing but will neglect to look at their working capital or liquidity position.
Working capital is defined as current assets, which are assets likely to be turned to cash in the next 12 months, minus current liabilities that are to be paid within the next 12 months. If you have current assets of $500,000 and current liabilities of $250,000, you have $250,000 of working capital.
We sometimes hear, “Why do I need working capital?” or that working capital is lazy equity. Working capital allows an operation to survive unprofitable periods when income levels are not high enough to cover all expenses – both family living and lender payments. Working capital is commonly measured as a percent of gross income or on a per unit basis, such as working capital/cow or working capital/crop acre. General benchmarks that we use, depending on the farming enterprise, are 10 to 20 percent working capital/gross income, minimum working capital/crop acre of $200 and working capital/cow of $400.
To answer the question, “Does my operation have enough liquidity?” you need to be able to look at either your cash flow or projection and determine if you have an operating cash flow shortage or projected loss. If you do, you then can look at the shortage and divide your working capital by the loss to determine your “burn rate” (how quickly your working capital will be used up).
If you have a loss of $100,000 and a current working capital of $250,000, your current burn rate is two and a half years. If you are fortunate to be operating at profitable levels you can still calculate a burn rate by comparing your working capital to the level of schedule term payments (principal and interest) due in the next 12 months. Generally, an operation should strive to have a burn rate greater than three years.
United FCS is working with producers to rebalance their operation’s working capital needs in the challenging environments that they face. We encourage you to complete a 2015 cash flow, or projection, for your operation to find where you are at. We recommend you speak with your local financial services officer this summer or early fall to review your 2015 projection, and discuss if your operation has enough liquidity to get through the next couple of years, and if not, what options are available to increase your liquidity.