Your working capital is one of the most important financial
measures on your farm. We know it’s important. Maybe we feel like we’ve heard
about it over and over. But, in good times, we start to forget why we need to
keep an eye on it.
One of the ag bankers I know has an example that paints a
pretty clear picture of how working capital affects the farm’s viability as a
business. He said the ag banker’s job in the ’90s was a little different than it
is now because the banker and his clients still had the ’80s fresh in their
Those of you who farmed in the ’80s know it was a
particularly volatile time in agriculture. With high interest rates, many
operations went out of business. Others struggled for years to get back on their
It became clear that in any given year a farming operation
could lose a lot of money. Farmers needed to have working capital that equaled
at least the amount they had at risk each year. The farmers who were left
standing learned a great deal from what they saw around them and perhaps from
their own financial problems.
The overall situation in ag right now is different. We’ve
seen some good years recently. I remember the ’80s, but many of you younger
farmers weren’t even born yet. Dad might have told you: “Things aren’t likely to
stay this good forever.”
Working capital is going to be important for farmers who
want to be in business for the long haul. Here’s some advice the banker
Think of your working capital as your ability to put in at
least a portion of next year’s crop. It’s what you have to work with before
you’d become reliant on the bank to be able to plant.
We ask our clients to strive for about 40 percent working
capital. That guarantees they’d be able to plant at least some of their next
crop without having to borrow money. If your operation includes livestock, that
percentage needs to be higher.
If you weren’t farming in the ’80s, find someone who was and
ask them to tell you about it. Learn from the past to help you build your
Here’s something to watch along with that: With the overall
U.S. economy strengthening, the Fed now may have room to raise interest rates,
so what will that mean for farmers?
You’d be affected the most on financing of fixed assets —
land, buildings, bins, machinery. Even if you have a fixed rate loan, banks
rarely will lock in rates for more than five years.
The bottom line is that the rates you have right now are not
necessarily locked in for a long period of time. Let’s say you have an interest
rate of 3.5 percent on a $2 million land note. You expect interest rates to stay
near that area.
Fast forward five years — what if they’ve doubled to 7
percent? Your balance sheet could take a hit, unless you already ran the numbers
to check whether your cash flow could handle an increase like that.
Land prices are at historic highs and interest rates are at
historic lows. If interest rates increase and land values don’t decrease, you
could be facing higher land payments than you originally planned for. Couple
that with lower revenue if grain prices decline and suddenly you’d be looking at
very thin to negative margins.
You can do a few things now to prepare. Let’s say you have a
term loan at 3.5 percent and you know your rate will reset in five years.
Figure out the impact an increase will have — and prepare
for it. If it goes up 3 percent, for example, what kind of revenue does your
operation need to make to stay profitable?
Once you see the numbers, decide whether you’re still
comfortable with that scenario. Is the income you’ll need realistic?
No one knows what the price of corn will look like in five
years. But if you’ll need to sell all of your corn at $8 to make your numbers
work, it’s not a good situation.
Manage your debt load and your debt coverage levels. That
means you know your costs and the revenue you need to cover those. The term debt
coverage benchmark for our clients is 1.5 times more in revenue than the cost of
the principal portion of your debt payment.
Understand what levels of debt you can and can’t afford to
take on — and how interest rates will affect that. Protect your operation from
any surprises by running the numbers now.