The Farm Financial Standards Council recommends 21 financial measures as part of its Financial Guidelines for Agriculture. A previous post looked at the Current Ratio (a measure of financial liquidity), and in this post we're going to look at another measure of liquidity, "Working capital as a percent of gross revenues."
The working capital to gross revenues measure (WC/GR) is a relative newcomer in financial analysis. Its primary benefit is measuring the amount of working capital needed, or to specify the size of working capital requirements. And, it helps determine this amount based on the total revenue (or sales) from an operation.
Related: Back to farm financial basics
The FFSC defines liquidity as "…the ability of a farm business to meet financial obligations as they come due in the ordinary course of business, without disrupting the normal operations of the business."
To paraphrase, liquidity is the ability to pay monthly bills, meet payroll, repay scheduled debt, etc. from current assets, without needing to sell business or investment assets to generate cash.
This financial measure is used by many agricultural lenders as part of analyzing borrower creditworthiness.
Applied to your farm business
WC/GR is computed by dividing working capital by gross revenues, and provides a percentage value that shows how large working capital is relative to gross (or total) revenue. Gross revenue is not the same as total cash receipts or gross income from a Schedule F. Rather, gross revenue is an accrual-based concept that measures the amount of revenue earned during a period, which is almost always different than the amount of cash received during a period.
A WC/GR measure of 20% or higher could probably be considered adequate, depending on the type of agriculture and the composition of current assets and liabilities. When price volatility is high, or revenue is expected to decline (as crop agriculture is experiencing presently), a higher percentage is obviously warranted.
Let's run an example. If an operation has revenue of $2,000,000, then the amount of working capital should be $400,000 ($2,000,000 x 20%) or higher, but even more (25-30% of gross revenues), would be advised when headed into a period of low income.
The WC/GR is relatively easy to compute and helps a business determine the amount of working capital they should be carrying. To learn more about this and other financial measures, get a copy of the "Financial Guidelines for Agriculture" by visiting the FFSC website.
Brought to you by Farm Financial Standards Council. The opinions of Todd Doehring are not necessarily those of Farm Futures or the Penton Farm Progress Group.