With grain prices plunging, reassessment of business strategy is becoming a critical priority. After the harvest season, many proactive grain producers will be pushing the pencil on 2015 budgets and cash flows.
The reality to some will be a negative margin or projected loss. Many ask which revenue and expense items should be included in calculating projections. Add up all revenue sources using your best estimates of production and prices. One may include some different financial scenarios given the level of the market and risk management strategies including crop insurance. On the expense side, add up all business expenses. Does this include principal and interest due on debt service? Yes. Do not forget to include withdrawals of family living costs and income taxes. If the calculations result in a negative margin, which is highly likely for many grain producers next year, the second line of defense will be working capital.
Working capital burn rate is a relatively new term in agriculture financial management. How is the burn rate calculated? As an example, assume a farm has $500,000 in current assets including inventory, receivables, prepaid expenses, growing crops, and cash. Assume $250,000 in current liabilities including accounts payable, operating loans, accrued expenses, and term debt principal due within 12 months. The formula for working capital is current assets minus current liabilities, which would result in $250,000 working capital in this example.
Next, divide the projected losses, for example $100,000, into the $250,000 of working capital, and the burn rate would be 2.5 years; however, be sure that current assets such as inventory of corn and soybeans have a risk management plan and the crops growing in the field are covered by insurance. If current assets are tied up in prepaid expenses, it may take time before these expenses are converted to revenue and income through sale of crops, especially when the crops are stored and sold later.
As a guideline, if the working capital burn rate is less than one year, it would be considered high risk. Above 3.5 years is indicative of a strong second line of defense and of course, between one and 3.5 years would be considered acceptable, but not stellar. To say the least, this winter and next year will be a balancing act as producers juggle quickly converting liquid assets to cash to keep their businesses in operation.