Rebuild Working Capital
These strategies help restore and protect liquidity during economic downturns.
Chris Hausman started farming full-time in the 1990s after his dad retired. He previously had taught high school vocational agriculture and advised farmers through Illinois Farm Business Farm Management (FBFM). Those experiences have helped guide his decision-making for more than 30 years.
“Working for FBFM was a great opportunity to learn what works and what doesn’t when you’re trying to make a profit during challenging economic times,” the Pesotum, Illinois, farmer says. “I witnessed a lot of struggling, and it left a big impression on me. I saw that you have to build and protect working capital when you can to successfully manage the down cycles.”
Hausman and his wife, Evonne, farm 1,400 acres of corn and soybeans, primarily on a 50/50 crop-share basis with landowners. He plans to retire in five to seven years and is evaluating options with family members and others regarding the operation’s future.
He has always focused on managing working capital wisely, but the last decade has really tested his strategies. His highest working capital levels ever came during 2010 through 2014, when corn and ethanol demand was expanding. He experienced record income those four years.
“We built working capital during that time and tried to extinguish as much debt as possible. We also socked away for retirement,” he says. “Then, the last two years, we have seen just the opposite. Our income has been at break-even to negative levels. Now, we are pulling from savings and borrowing when necessary to maintain working capital. The good news is interest rates are a bargain compared to the 18% we had in the 1980s.”
WIDE SWINGS. Dwight Raab, Illinois FBFM CEO, confirms wide working capital swings have affected farmer financials. From 2012 to 2015, average farm income for FBFM members went from a record high to a record low. Farmers now are in their fourth straight year of declining farm income.
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“The deterioration in economic conditions requires a change in mind-set to make only necessary expenditures and to manage cash-flow to cover costs and limit borrowing,” says Hausman, who does monitor his farm’s liquidity throughout the year. He prefers to track net worth, which he defines as what he would have if he sold all assets and paid off all debt.
“An accrual income statement is more useful than a balance sheet in determining profitability,” he says. “Don’t use Schedule Fs and 1040s as measures of profitability. Know what your liquid assets are versus current debt in the short-term to manage working capital and focus on preventative maintenance of machinery instead of replacing it for tax purposes.”
Overall, Raab says debt-to-asset ratios remain strong, although they have decreased during the last 10 years. Asset values are increasing at a rate faster than debt load.
“Liquidity remains good [among FBFM members], with median working capital of $305 per acre; but this is a marked decrease from the record working capital of $540 per acre in 2012,” Raab says. “For the short-term, equity and solvency are such that lower profitability can be weathered.”
To maintain liquidity, Raab recommends farmers have at least $200 per acre of working capital. Anything below $100 per acre is a red flag. A current ratio near 2 is good. As the ratio falls closer to 1, farmers should be aware they are using up too much working capital.
WORKING CAPITAL SOLUTIONS. Raab encourages farmers to take steps as they can to rebuild and protect working capital, and weather lower profitability. While good crop yields the last few years helped to mitigate working-capital losses, he says low prices create positive cash-flow and profit challenges.
Crop insurance is one way to improve a risk-management plan to help protect working capital, says Hausman, who also uses other insurance policies to cover catastrophic losses. “Do not overinsure,” he says. “Every wrench in the toolbox does not need to be insured.”
Hausman also believes sound agronomic practices are a critical part of a risk-management plan. His goal is to maximize gross returns and inputs efficiently to make the best use of working capital. He also is willing to forgo new technology through leaner years, and he uses a marketing plan as an offensive strategy rather than reacting to prices. Finally, Hausman monitors family living expenditures. His wife previously worked off the farm to provide health insurance.
“You have to do what you can to help fill your working-capital gap and improve overall health of the operation,” he says. “For us, when we had three children at home, that [health insurance provided through his wife’s employer] was important.”
Raab notes family living expenses and off-farm income can affect equity. While some years, equity may increase because of higher land values, other years, it declines due to lower profitability. Farmers who can manage equity to survive low-profit years and rebuild working capital may find they are in a position to acquire more land or take advantage of machinery buying discounts.
“Work with your lender to prevent any surprises,” Hausman advises. “And, for young or beginning farmers, take stock in this life lesson of lower profitability to manage for your future.”
Pad Your Profitability
Purdue University’s Top Farmer Conference, held earlier this year, addressed financial strategies farmers can use for future success. They include:
> Benchmark all of your farm numbers, then work to cut costs and enhance productivity.
> Keep a greater percentage of your earnings.
> Direct more retained earnings to current assets.
> Develop short-term and long-term goals.
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