The hot topic for agriculture heading into 2023
and beyond is working capital. Two years of
profitability have put producers in a solid financial
position. In the territory served by Frontier Farm Credit, many grain
operators have hundreds of dollars of working
capital per acre. The focus for next year should be
on preserving this liquidity for the challenges –
and opportunities – that lie ahead.
Most producers remember the difficult transition between
2012 and 2013 to 2016, when high commodity prices fell faster
than expenses, reducing working capital and cash flow. A
contraction in today’s record-high commodity prices might be
inevitable but financial pain isn’t. The strategies below can help
producers protect the liquidity they have rebuilt.
Limit Capital Purchases to Needs, Not Wants
Shortages of equipment and vehicles make this easier to
achieve. But history shows that some of the poorest capital
investment decisions are made in the best economic times.
Approach capital investments with the same discipline in
good times as you would in tougher times. Understand
how investments, capital or otherwise, impact your cost
structure.
Pay Off Operating Debt or Higher-Interest Debt on Shorter-Term Loans Only
Most producers should not prepay their low interest, long-term debt. One reason: Financing an opportunity – say, a
land purchase or a fixed asset – will cost more today than
most fixed-rate debt currently on balance sheets. Using
working capital to pay down low-cost debt only to replace
it with higher-cost debt has negative long-term financial
implications.
Manage Your Term-Debt Payments
Ensure total annual debt payments can be serviced in
a lower-margin environment. Recent profits are two to
three times higher than average for the industry. If returns
dropped 50% or 65%, could you still make your payments? If
you can’t cash flow payments, your liquidity will be further
drained by compensating for the shortfall.
Maintain a Reasonable Standard of Living
Family living expenses tend to rise in an environment of
strong profits and large cash reserves. Factor in today’s
inflationary environment, and family living can quickly eat
into working capital when profit margins tighten.
So how much liquidity is enough? The rule of thumb is to
maintain working capital equal to 25% of gross income.
But with both commodity prices and farm expenses at
unprecedented highs, it is commonplace for grain producers to
maintain working capital of 50%.
This kind of financial strength provides opportunity for growth.
Evaluate what an investment would do to your liquidity and
your ability to service debt in a more traditional, low-margin
environment. If working capital were to remain strong and
you could meet your debt obligations, it could be a good time
to expand. Your Frontier Farm Credit financial advisor is available to
discuss considerations and options.
