Why You Should Focus on Working Capital

Why You Should Focus on Working Capital

Top managers should analyze finances in detail.

A common trait found in top performing farm managers is a focused approach towards efficiency and a sharp pencil. Top managers focus on working capital and cash flow, two topics we will touch on here and in next week's blog.

The current ag climate warrants all producers take an even closer look at costs and returns. So far, 2014 has shown some signs of concern for grain producers with commodities trading at or below the cost of production. Meanwhile, livestock and dairy producers, especially cow/calf operations, may see an opportunity to improve farm equity.

Why You Should Focus on Working Capital

Regardless of what enterprise mix constitutes your farming operation, prudent management is the cornerstone of fiscal fitness. Good financial management ensures that your operation can weather a storm or efficiently allocate net worth to be productive in future years.

Working capital is the difference between current assets and current liabilities, and is generated from net farm income (NFI). Current assets include cash and marketable grain/livestock inventories that will be sold within a year. Current liabilities are those that are due within one year such as operating notes, yearly principle and accrued interest payments on term debt, etc.

Increasing working capital is important so that your operation can better withstand short-run profit shortfalls, while taking advantage of opportunities as they arise.

NFI is the difference between total income and total expense, including gain or loss on capital asset sales.  The difference can be thought of as the amount returned to owner equity, management, and unpaid labor.

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There are only four places that NFI can go: 1) family living or partner withdrawals, 2) income and social security tax payments, 3) increases in assets, and 4) decreases in liabilities through principal payments, all of which affect net worth.

Number three is where positive NFI can be used to increase working capital by retaining returns in liquid assets.  Positive NFI can also be applied to number four and still increase working capital by reducing liabilities.

With shrinking margins in grain commodities, many producers will have a lower NFI for 2014 relative to recent years.  Concern arises when debt servicing and family living expenses are based on years of relatively high, and in some cases, record-breaking incomes.  There is a good chance that balance sheets completed at the end of 2014 will not show as high of an increase in cost-basis net worth as years passed.  This is where managers must sharpen their pencils and take time to analyze their operations in detail.

Next week we'll take a look at what to do to resolve a cash flow crunch.

Brought to you by Farm Financial Standards Council. The opinions of Jonathan D Shepherd are not necessarily those of Farm Futures or the Penton Farm Progress Group.  For more information on the Farm Financial Standards Council go to the website or email Carroll Merry at [email protected].

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