Why Working Capital Matters to Lenders
As production agriculture enters its sixth year of narrow profit margins, it is critical to be thinking about your working capital ratio and how to maintain or improve it. To many bankers and financial lenders, it is perhaps the most important financial element to an operation.
But for many producers, it’s not a priority until it is. I’ve heard it compared to oxygen in the human body — easy to ignore until it’s no longer there.
If you’re not familiar with the term, working capital ratio is simply computed by dividing current assets by current liabilities. Current is defined as assets that can be converted to cash within one year, and obligations that will have to be met within one year. This also may be commonly expressed as net working capital (current assets minus current liabilities).
In good economic times, the working capital position is typically strong and not that much attention is paid to it. In tougher economic times, it becomes the difference between being able to meet obligations or being in serious financial trouble.
A few potential ways to improve your working capital position in 2020 could include:
- Selling nonproductive assets, such as equipment or land, that are no longer contributing to the economic earnings of the farm. In leaner economic times, astute managers will eliminate nonessential items to help build or replenish working capital.
- Restructuring loans to move current or intermediate term debt to long-term financing on real estate. This can be a difficult decision to make when that land is paid off, but it may be required to keep the farm operating properly in the short and intermediate term.
Even if your farm is not currently experiencing financial stress, building and maintaining a strong working capital position still should be a top priority. This strong position will enable the farm to perform well in various parts of the agricultural economic cycle and will allow you to take advantage of opportunities that may arise in the coming months and years.
Warren Buffett said, “Opportunities come infrequently. When it rains gold, put out the bucket, not the thimble.” Having a very solid working capital position will allow you to put the bucket out, whether it’s buying land, cattle or another agricultural asset at a great price.