It’s All About Cash Flow – Until It Slows Down …

Wednesday, January 13 at 08:05 AM
Category: Business Banking

In the agricultural economy, producers are experiencing varying levels of success across the broad spectrum we have in Southwest Missouri. Two extreme examples are seen in the cattle and crop sectors. Cow-calf producers are seeing strong margins with continued support in the cattle futures and lower feed costs. Meanwhile, crop producers have seen profits reduce significantly due to lower prices following the large fall harvest of 2014 and significant inventory carryover. This is the nature of agriculture.  

Cash flow is directly tied to the profitability of a given producer in any industry. When margins are strong, cash flow is strong. When margins are weak, then cash flow follows suit. Successful producers anticipate these fluctuations and prepare accordingly. While there are a number of financial areas that need to be evaluated, the most important one in times of thin profits is working capital.

Working capital is defined as current assets minus current liabilities. Current assets (cash, receivables, inventories, prepaid expenses, cash invested in growing crops, etc.) are the items that are cash or can be converted to cash within 12 months. Current liabilities (accounts payable, line of credit, lease payments, interest payments, principal payments on term debt, etc.) are the obligations that must be paid within the next 12 months. So, working capital provides a quick look at what resources a producer has to meet their obligations in the near term. And, it serves as the primary backstop for weak cash flow.

In the past several years, many grain producers had the opportunity to build up and protect working capital when prices were running at their historical highs. Unfortunately, the temptation to use this ‘excess’ cash to purchase equipment or real estate was too strong for many. And, as a result, working capital was depleted, leaving reserves less robust than they should be given the recent decline in operating margins.

Cattle producers should watch and learn from their counterparts in the grain industry. They are facing similar temptations to expand their operation by purchasing additional cattle, equipment or land with ‘excess’ cash. While this could be a prudent move resulting in enhanced profitability, producers can’t predict when a down turn in cattle prices may come. So, producers should consider reducing or eliminating dependence on accounts payable or lines of credit before paying cash for capital purchases. Doing this will help ensure that there are enough working capital reserves to shore up weaker margins in the future.

Having said this, not all working capital is created equal. A positive working capital number does not automatically mean they won’t have problems with cash. For instance, if the majority of a producer’s assets are in marketable inventories (calves, crops, etc.), then the timing of when these products are sold comes into play. For instance, it wouldn’t be uncommon this year for a grain producer to have contracted their corn for delivery at a later date to try to get a better price. While this may result in a profitable sale, he may experience a cash flow crunch while trying to make loan payments or pay fertilizer bills that are due in the meantime.  

To help anticipate when shortages may occur, it might be beneficial to use a calendar to ‘map’ out when expenses and payments are scheduled and compare this to when inventories will be (or should be) marketed. Many producers track these things in their head – which works well enough when margins are strong. However, when profits are tight, there will be less excess cash flow being generated from the periodic sales. So, it becomes vitally important to keep track of when the potential shortfalls could occur and to plan accordingly.

In summary, it’s true that cash flow is the lifeblood of any business – agricultural or commercial. When margins shrink and the flow slows down, then the business’ reserves may be needed to fill in the gaps. It’s been said that ‘equity doesn’t pay the bills’, which is so true. The primary stopgap measure a producer has is working capital. So, make sure you’re preserving this resource in both good times and bad – because no one knows what the future may hold.
 
Tags: Arvest Biz, Business Banking, Cash Management
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