In Farming, Liquidity Is King

During the height of planting, one of our farmers acquired 1,000+ acres of rental land (May). It's clearly just too late in the year to be looking for new farmland. He was unable to renew his operating note with the producer from whom he purchased the farmland for the 2021 season. His bank's refusal to extend the note was due to a shortage of working capital.

Although I don't have all of the information, I believe this producer used his working capital to make substantial ROI-positive investments in his company. His banker assured him that if he paid cash for the assets, the bank would be willing to refinance them if necessary.
When the time came to refinance (along with lower commodity prices), the bank refused to lend against those properties. His balance sheet has been buffeted by lower commodity prices, machinery values, and farmland valuations from the time he made the investments until now. The bank's business is to protect its money, and that's exactly what they're doing right now.

In a similar vein, farmers should be able to determine new rental opportunities using tools. These tools showed him that this opportunity would add $100,000 to his bottom line in cash flow. Opportunity comes with uncertainty!

What really matters is farm liquidity.
Here's what we would've learned at the time of the investments if we were in this case.
1. Working resources will be exhausted drastically.
2. The bank expressed an interest in refinancing the investments in the future.
With the benefit of hindsight, I would have immediately requested a line of credit on those properties from the bank. Agriculture and other commodity-based industries are inherently cyclical. The main element of sound farm financial management is preparing for these cyclical downturns.

Working capital acts as an important buffer between expected sales and the revenue assurance provided by crop insurance. The cover offered by crop insurance is the reason why banks are able to underwrite operating debt at 3-5 percent interest rates. Crop insurance is the reason why banks consider an investment in a growing crop to be secure collateral, despite the fact that it is far from ideal.

I'm going to introduce a term I'm calling Working Capital "Plus."

In today's low-interest-rate world, cash is a low-return asset. Working capital is essential for a farm's financial health because it provides liquidity.
A farm's liquidity allows it to absorb minor losses while remaining solvent. A bankrupt company is a company on life support!

Assets with a high return on investment, such as drain tile or grain storage, can provide a farm with better long-term returns than working capital investments. Working capital is useful because it allows farms to fund the usual difference between commodity costs and crop insurance revenue guarantees (if it isn't clear, production costs are higher than revenue guarantees in most years).

I don't recommend using any of your working capital to invest in a farm. However, there is a way to make these investments while keeping valuable liquidity on hand to help you cross the production cost/revenue guarantee gap if necessary.

1. Rank possible investments for your business based on their return on investment.
2. Talk to your lender about the possibility of paying for these investments in cash and having a short-term line of credit against the properties.
3. Confirm with your banker that the collateral you choose is appropriate.
4. Obtain the line of credit as soon as possible.

I recently read about a producer who put this system in place. He had a 50 percent working capital ratio (of estimated annual revenue). He agreed to spend approximately 20% of his working capital on grain storage. He then got a line of credit for 60% of the cost of his storage investment. His current amount of working capital is 30%, but his overall liquidity is 42%.

This isn't a "one-size-fits-all" technique, as is often the case. Make sure your banker is on board before adopting a plan like this. Overall, your balance sheet is a snapshot of the value that you've generated. In handling it, be constructive rather than reactive, and make sure to prepare for the inevitable cyclical downturns.

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