If you hear the term “working capital”, what comes to your mind? Working capital (WC) is a farm financial measure we discuss often here at AgCountry with patrons. The accounting definition of WC is current assets minus current liabilities equals WC.
Current assets are items that will typically be converted to cash within the next 12 months. For a crop operation, this includes crop inventories; hedge account equity; pre-paid crop inputs for the next crop year; accounts receivable, such as an insurance claim coming; accounts receivable, such as deferred grain sales or livestock sales income; or income you’re waiting on from some custom work you did. In a livestock operation, it also includes items like feed; market livestock inventory; farm products, such as delivered milk for the last month and the check is on its way.
What is an obvious current asset I failed to mention? Cash. How many times have you heard cash is king? Cash is the one current asset that ALL businesses need to make the business go, whether the business is farming, construction, retail, manufacturing, service businesses, etc. I’m not saying anything that you as the reader don’t already know. Your farm is constantly converting the farm production it creates into cash.
Current liabilities need to be paid within the next 12 months. This includes accounts payable - bills that must be paid for work you received, repairs completed, insurance premium unpaid, etc. Other payable examples include real estate taxes, payroll tax, feed bill, and custom work. Current liabilities also include operating loans, principal payments (called current portion) due within the next 12 months on term and mortgage debts, accrued interest on all debt, and any outstanding checks or drafts that have not cleared the bank or AgCountry.
Positive WC means the farm has excess current assets after all current liabilities are paid, at least on paper.
Working capital divided by average gross farm income (WC/AGI) is one way to measure the amount of your excess WC. Using easy math, if a farm operation has $250,000 of working capital and averages $1 million of farm income, that is 25% WC/AGI measure. The farm has one-fourth of its annual income as a working capital cushion.
I like how a former customer (bless his soul) described working capital. He said, “his goal was to be a crop ahead.” In other words, he wanted enough WC set aside to cover a full crop year if he didn’t get a crop, which was his way of self-insuring.
Negative working capital means the farm has more current liabilities than it has current assets to cover them. This is a concerning position. How will all the bills get paid?
If a farm has a profitable year, generally we see an increase in WC. The opposite is also true - a loss year will generally reduce working capital.
Simply put, working capital is your excess money (capital) at work in the farm. Your operation is less reliant on debt to fund day-to-day operating needs. Building WC, retaining WC, and managing your farm’s WC is your challenge as the farm owner. However, everything becomes easier when these concepts are understood along with the financial power it provides by having it.
As you update year-end financial information, are you seeing WC increase year over year? Better agriculture economics for the past year or so has helped most farm units. If that is true for your farm operation, what are you planning to do with strengthened WC? Here are some options: 1. Keep it as a larger financial cushion. Fund more of your expenses without having to use debt. Working capital is your shock absorber. A good goal is to have working capital enough to cover one-third of your farm expenses. 2. Purchase an asset with working capital. 3. Paydown on some term debt.
Visit with your AgCountry loan officer about your farm operation’s working capital. We can offer ideas to help you manage your working capital, which is the result of your hard work to get it.
