Minding Ag's Business

Don't Underfund Your War Chest

Working capital as a percent of revenue has stayed flat, despite rapid growth in value of farm production. (Chart courtesy of AgriSolutions)

HADDONFIELD, N.J. (DTN) -- This is your chief financial officer speaking: Your grain farm may be generating more revenue than at any other time in history, but on average you're doing a better job of spending than saving it.

That's the conclusion that AgriSolutions financial consultant Sam Bachman makes after studying five-year trends of three-dozen commercial Midwest grain operations in their database.

He analyzed two ways lenders look at farm liquidity -- working capital and working capital as a percent of revenue. Those are such significant indicators of financial health, some lenders mandate minimums as part of loan covenants. Violate pre-agreed standards, and your loan could come under intense scrutiny.

Overall Midwest farm revenues have exploded in recent years, from an average of about $1.6 million in 2007 to more than $3 million per farm in 2011. (Bachman counts the "value of farm production," or VFP, as gross farm revenue and unsold inventory less cash rents, purchased feed and livestock or commodities specifically purchased for resale). "The goal is to provide a fair basis for comparing different farm operations based on the value of what they actually produce," he said.

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What hasn't grown nearly as fast is working capital. AgriSolutions' sample farmers set aside more than $1 million each in items like cash, grain inventories and livestock in 2011, up from about $600,000 in 2007. But as a percent of VFP, their working capital has been nearly flat the past five years, Bachman noted.

"This implies that there has been no real improvement in working capital when adjusted for the business 'salary,'" Bachman says. Just like wage earners, farmers expand their standard of living and expenses to their new, higher incomes.

Generally, producers need at least 25% of their VFP in working capital, but over 35% is average in many databases.

Farmers also need to be aware what types of working capital they hold. Livestock, grain inventories and growing crops are still vulnerable to disease, market crashes and storms, so they need insurance protection if available.

Lenders often stress test their loan portfolios for shocks to commodity prices and asset values, so be sure you understand what a significant revaluation of such items would do to your liquidity, Bachman said. "I'm worried that farmers may perceive they are doing much better in preparing for the rainy day than they are."

Read and comment on all DTN Ag Business Benchmarks on the Minding Ag's Business blog.

Follow Marcia Taylor on Twitter@MarciaZTaylor.

Marcia Taylor can be reached at marcia.taylor@telventdtn.com

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