One of the joys of writing this column is to expand upon questions that I get in seminars or via email. The following question came from one of my loyal online readers concerning profits.
“I farm corn and soybeans in Iowa and had a strong year with excellent yields and high prices. How should I spend these profits after taxes? Should I pay down machinery installment loans or simply pay cash for my 2009 crop inputs? I want to strengthen my working capital.”
First, I would say congratulations to my reader from Iowa on a profitable year. In our business, we have utilized the 60-30-10 rule – which sounds like a fertilizer analysis – to develop strategies for profits.
First, 60% of profits are used toward the ultimate goal of increasing earned net worth. This can be done by paying down debt, incrementally increasing the size of the business or building efficiencies. While most producers want to get their land paid for, I suggest paying down the highest-interest cost, shortest-term debt first.
Your ultimate goal is to increase working capital to 33% of revenue or expenses, particularly if you have growth plans or project tremendous volatility in revenues or cost and have no marketing or risk management plan. Utilize 30% of profits specifically to build working capital. Yes, you may be required to pay income taxes, but the ultimate goal is to have a financial fortress for unforeseen circumstances or to take advantage of opportunities. Even cash in the bank at a low rate of return can net you a long-term high rate of return. In a deflationary environment, your dollars go further in acquiring assets at 70¢ on a dollar.
Be careful of prepaying or just paying cash for all inputs. Conduct financial due diligence on your suppliers and agribusinesses to make sure they are financially sound. Second, bargain for discounts with your cash to lower your cost of production. Third, hold a little cash in reserve for rainy days.
What about the remaining 10%? That is for you to use at your discretion. Any strategy needs to be tested against your business, family and personal goals.
Editor’s note: Dave Kohl, Corn & Soybean Digest trends editor, is an ag economist specializing in business management and ag finance. He recently retired from Virginia Tech, but continues to conduct applied research and travel extensively in the U.S. and Canada, teaching ag and banking seminars and speaking to producer and agribusiness groups. He can be reached at sullylab@vt.edu.