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Financial Management in a Downturn

Date: 
Author: 
Paul Dietmann
Educational Opportunities: 
Articles
Interests: 
Grain, Dairy, Swine, Beef, Timber, Renewable Energy, Young, Beginning Farmers
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During a down cycle in commodity prices, it’s only natural for farmers to concentrate their focus on the farm’s cash flow, and tighten up their financial mangement practices.  You want to know how much cash income is going to be generated each month, and what bills need to be paid.

However, it’s also important to keep an eye on the farm’s balance sheet during times when cash flow is tight.   The day-to-day financial management decisions being made to keep the farm operating will oftentimes have an impact on the  balance sheet.

Typically, we recommend that the farm’s balance sheet be updated at least once a year on January 1.  This is still sound advice; updating the balance sheet every year on January 1 aligns it with the farm’s Schedule F and allows for a full-blown analysis of the farm’s profitability, financial efficiency, and other important financial measures. 

There are good reasons to update the balance sheet more often than once-a-year, particularly during challenging times.  First, it’s easy to become discouraged when commodity prices are low.  An up-to-date balance sheet can show that the farm is making financial progress and building equity, even though the checking account balance always seems to be awfully low. 

Second, updating the balance sheet frequently—either monthly or quarterly—allows for much closer monitoring of the farm’s financial position.  It will alert us more quickly to areas of concern, and provide an opportunity to take action to correct issues before they’ve had an entire year to fester.

During times of tight cash flow, we want to pay particular attention to the top part of the balance sheet; current assets and current liabilities.  Current assets include cash and anything that will either be turned into cash or used up on the farm within a year, such as market livestock, crop and feed inventories, and accounts receivable.  Current liabilities are  items that are due to be paid now or will come due within a year; including open accounts, operating loans, credit card debt, accrued interest, and the principal due within the next year on longer term loans such as machinery loans or mortgages.

When looking at the list of current assets, we want to see 10-15% of the total current assets being held in cash or “near cash” items.  A “near cash” example is corn in a bin that is intended to be sold for cash.  These are the most readily-available sources of money when the farm needs it.  We don’t want to have to sell off feed inventory to generate cash, which could put the farm’s productivity at risk. Next, we want to calculate the farm’s net working capital.  Current assets minus current liabilities = net working capital.  The farm’s net working capital should be at least 15% of its annual gross farm income.  This is an important measure of the farm’s ability to withstand tough times.

Many farms have seen their net working capital take a hit over the past few years.  Current assets may not have changed very much, but accounts payable, operating loan balances, and credit card debt have all increased. 

What can you do if your working capital position has gotten out-of-whack?  You may need to shift some current liabilities down the balance sheet by converting them to longer-term debt.  This is particularly true if you have balances that are compounding at very high interest rates such as credit card debt.  Think of this shift to longer-term debt as a temporary action, and have a plan in mind to pay the debt back down when commodity prices are more favorable.

You may also want to consider selling off some underutilized assets such as obsolete equipment or unproductive land.  With the increase in recent years in the number of small farms, you may find that equipment you outgrew long ago is in hot demand by a different style of farmer.  Also, the relative strength in the nonfarm economy has been driving up both demand and prices in the recreation land market.

Upon closer examination of your balance sheet you may find that it makes sense to add productive assets right now.  Some categories of machinery and livestock are available at bargain prices today compared to a couple of years ago.  And, while interest rates are rising, they are still at historic lows.  If you are thinking about financing significant capital purchases, you may find it helpful to learn how to calculate the Internal Rate of Return on a capital investment.

Farming is a cyclical business.  Periods of low prices won’t last forever, and neither will the times when prices are at record setting highs.  Keeping a close watch on your farm’s balance sheet and making adjustments quickly will help position your farm to thrive in any economic environment.
 
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