Since 2009, just after the first time corn prices ran to $8, I’ve been emphasizing to growers than they need to build working capital. Early on, I used a pretty simple rule of thumb: growers need at least one full year of land charges in extra working capital. This extra working capital was cash that could be lost when prices inevitably turned lower. But that was a time of high prices and profitability, when it was easy for growers to build stronger balance sheets. In 2016, easy profitability is a thing of the past. Many growers will be lucky to have breakeven cash flow, so telling them to build cash reserves is not helpful. Instead, I’m now emphasizing that growers who are expected to lose money in 2016 calculate (and watch) their working capital and land equity burn rates. These are two quick measures of the precariousness of growers’ current financial condition, and indicate the urgency that farmers should use in undertaking managerial changes. In this post, we’ll focus on the working capital burn rate and why it matters. Next time, we’ll discuss the land equity burn rate.
Before going any further, let’s review a little bit of accounting. According to the New York State Society of CPAs, working capital is equal to current assets minus current liabilities. Current assets are assets that one can reasonably expect to convert into cash, sell, or consume in operations within a single marketing year, or within a year if more than one cycle is completed each year. For a crop farm, this is cash, securities, pre-paid inputs, grain inventories, deferred payments, and any other accounts receivables. Current liabilities are obligations that must be met within the marketing year. For a crop farm, these are primarily this year’s payments for long term debt, operating loans, and any other obligations that are due in the current marketing year. The WCBR is simply working capital divided by 2016’s losses. It is a measure of the number of years that the operation can sustain 2016 market conditions before working capital is exhausted. This is important as its a measure of how long the farm can continue to operate before being forced to change its capital structure, either by selling, shrinking, or refinancing; in other words, it’s the number of years that a grower can continue to operate before being forced to make major changes.
Using 2015 FINBIN data, we can construct some examples for 2016. Using data on crop farms with 2000+ acres, separated into quintiles1 by profitability allows us to see the situations that some farmers will find themselves in this year, and potentially more farms will be in in 2017. To approximate 2016 crop income, I’ve reduced total crop sales, and therefore profits, by 10% in line with the 2016 market year average estimated prices for corn, soybeans, and wheat compared to 2015.
Column 1 is the 144 least profitable crop farms with 2000 or more acres in the FINBIN dataset. When their profits are further reduced by 10% of crop sales to represent hypothetical returns, their projected losses are over twice their current working capital, resulting in a WCBR of less than one year–these farms are already on life support, and need to take drastic actions now. These are the farms that likely couldn’t renew their lines in 2016, and even if they somehow did, will have to refinance during 2016 just to get the bills paid. In column 2 are the bottom 20%-40% of farms. These farms are in a less dire situation with a WCBR of 3 years–enough time to hopefully adjust land rents, and maybe for prices to improve somewhat. But without those changes, renewing the operating line in 2017 will be more difficult, and likely impossible in 2018. Finally, the middle 20%, those from 40%-60%, have a burn rate of 24 years–demonstrating more than adequate working capital reserves to weather these next few years.
In the next post, we’ll discuss the land equity burn rate, LEBR, which is the ultimate ‘last ditch’ measure of a farm’s ability to survive by measuring how long equity can be drawn down to finance further losses.