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Decision making with negative margins, part 1

The reality is setting in that some producers, particularly those in the grain sector, will experience negative margins in 2015, which is something not experienced in many years. How can a producer troubleshoot their business and work with their lender when margins are tight, or even negative?

The reality of this situation is that you will have to build a business case for your lender if your debt coverage ratio, i.e. repayment capacity to debt service requirements, is below 100%, which according to some of the farm record data could be up to 50% of producers. In building your business case, demonstrate that your business has a trend of profitability. No, profitability should not be based on income tax returns, where the objective is to minimize taxes. However, develop accrual-adjusted statements which account for changes in inventory, receivables, prepaid expenses, and crops growing in the field, as well as changes in accounts payable and accrued expenses. Your lender will place emphasis on operating lines of credit to determine whether you have offsetting inventory and current assets to meet outstanding balances.

Next, demonstrate that you have the ability and the discipline to build cash or true working capital in favorable economic years. Working capital of less than 10% of revenue will not cut it when coverage margin is below 100%. However, if your working capital to revenue is above 40%, this illustrates to your lender the ability to plan ahead and execute a plan for adversity.

In building your business case, can you “trim some fat” off living expense withdrawals or dividends extracted from the business? Belt-tightening on the personal financial side will not be an option but a requirement because family living withdrawals have become a main competitor for cash flow to meet debt service requirements.

Do not wait too long before taking action if you anticipate financial stress on the horizon. Organizing your financials and meeting with your lender can be a proactive practice so that troubleshooting can begin. Lenders in agriculture are sharing with me that some producers have the avoidance mentality, which only reduces your opportunities to do something constructive in business turnaround.

Next time I will discuss the decision making plan.

TAGS: Soybeans Corn
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