I believe there are tremendous opportunities in production agriculture. I've said in seminars that farmers will have the opportunity to create more wealth in production agriculture in the next 10 years than what's been created in the last 25 years. However, risk is also greater because of reduced margins, increased price volatility and increasing costs.
A client recently summarized his needs from our company by asking if he should step on the growth accelerator harder, or if he should ease up on his growth goals. He said, “I have a sizable net worth and I don't want to lose it.” More and more top growers are facing this situation.
This customer's goal is to grow as fast as possible. But what's too fast? And what are key pressure points, financially and operationally, that you need to watch to find that balance?
Let's look at some of the critical areas and the acceptable ranges to watch.
Pay attention to working capital. Working capital is calculated by taking your current assets minus current liabilities. Then take that figure and divide it by your annual cash expenses, including payments and living. If that figure is less than 20%, we consider it a red light area and it needs watching.
A red light doesn't necessarily mean the situation is bad. In fact, the vast majority of our clients have red light working capital. They want to push the edge of the envelope and grow as fast as they can. Knowing your working capital percentage, what affects it, and how to manage it is more important than the particular figure.
Working capital needs to be evaluated before key decisions are made. How to structure debt on machinery or real estate is a decision that depends on your working capital level. Look at alternatives, such as how much to put down on a purchase or whether to fix the interest rates.
The decision to lease rather than buy is another option that depends on working capital levels.
I was recently helping a young Illinois farmer who has limited working capital and is highly leveraged. After analysis, he made the decision to sell his combine and lease one with a neighbor. That decision not only improved his working capital, it resulted in lowered debt leverage and improved return on equity, all with one action.
A key factor is working capital because it's the first “shock absorber” in your financial structure to withstand adversity. It also gives an indication of which other risk management tools or practices you need to use. For example, a higher level of crop insurance may be needed if working capital is limited. Forward grain pricing may be a good decision if it meets the gross dollars per acre you need.
Working capital also impacts profitability as you pay interest on your current liabilities. Interest rates have been low on operating lines the past several years. But as I wrote in my last column, that could change in the future. Increasing rates can really hurt profitability. It means being “risk wise” is even more important.
Moe Russell is president of Russell Consulting Group, Panora, IA. Russell previously spent 26 years with Farm Credit Services as a division president. For more risk management tips, check his Web site (www.russellconsulting.net) or call toll-free 877-333-6135.