Last week I discussed the necessity of good gauges allowing us to be certain our farm machinery is running efficiently – and the similarity of the business side of our farm needing reliable gauges as well. Today I'll cover two of four important gauges for your business; "working capital as a% of gross revenue" and "equity". Many of you call "equity" net worth.
Working capital as a percent of gross sales helps us know what kind of flexibility we can afford in our decision making. Simply stated, this measurement is (current assets – current liabilities) / gross farm sales. Strong working capital allows farmers the cushion to absorb mistakes or unanticipated problems and still move the farm forward. It also provides the ability to take advantage of opportunities on short notice.
While each farm has unique needs and circumstances, it's a fact that low working capital means no room for error. You won't be able to take advantage of new opportunities like expansion or innovations. That's why as a company we work our clients toward a target of 40% working capital.
This provides the peace of mind to know the farm is healthy while it grows. The key drivers to managing this number are constant work toward increased production, being sure marketing opportunities are captured, managing unnecessary expenses and having the right crop insurance in place, preventing a yield or revenue problem from setting the operation back.
These gauges are important to read right now, but also critical to track over time. One of the most important to track for continual improvement over time is the second gauge – equity. There's no doubt that farming is capital intensive, and never more so than today. Equity gives us the ability to work with banks to effectively finance the operation. It provides the flexibility to drive decisions that are right for our operation rather than merely what is best for our lender.
By tracking our growth in equity over time, we can be confident that the individual decisions we are making on a daily basis are yielding returns that lead to a successful farm. It's our litmus test to know if we are getting better every year at putting our money to work for us. Decreasing equity year after year should be cause for alarm driving us to evaluate our management of the farm.
Next week, I'll discuss the two more important gauges for your farm.