February 1, 2023
In the last article, our discussion centered on the ten-year down cycle and the strategies that were developed post super cycle and pandemic. Let's continue to discuss what worked then, and what may work if we encounter another “grinder” cycle.
A strategy that worked well post super cycle and during the financial “grinder” years was a focus on working capital. In examining farm record databases, the top 20 percent of profitable producers generally have greater than 40 percent of working capital to revenue or expenses. The bottom 20 percent of producers generally keep less than 15 percent and sometimes less than 10 percent of working capital to revenue or expenses. That extra 25 to 30 percent of working capital is critical in a downturn as a blocking strategy if profitability dips or negative margins occur. One must match current assets and quickness to cash to meet high priority current liabilities or a concept called “true working capital” without disrupting normal operations.
If your business has a deficit of working capital and insufficient profits and cash flow, then a refinance strategy utilizing equity may be the solution. In this situation, your lender will usually require an action plan outlining how profit and cash flow issues can be resolved. As a best practice, a timeline should be developed to determine how quickly the working capital received through a refinance will last if the strategies do not work, otherwise known as the working capital burn rate.
Remember the rule of three and the green, yellow, and red-light indicators. If one has sufficient equity, plan on a debt refinance. This is possibly a green light. Back-to-back refinances within a two to four-year period are a cautionary yellow light to a lender. A “red-light” high-risk refinance strategy is when a business has three debt refinances within a four to six-year period. One not only loses money in this situation, but also equity.
Finally, family living expenses, which are often paid out of operating loans, must be addressed. What are the budget busters, particularly in these inflationary times? Next, how many families are living out of business earnings? Prudent personal financial management and budgets are just as important as the farm business budget. If the “miscellaneous” and “other” categories exceed 10 percent of the budget, they are often a major culprit when problems occur.
Now is the time to map out your future strategy having learned from the pandemic, government assistance, and mini super cycle where price increases were ahead of cost increases. The tools and techniques outlined in these articles have withstood the test of time, and will need to be tweaked for your situation as we head into 2023 through 2026.
The opinions of David Kohl are not necessarily those of Corn+Soybean Digest or Farm Progress.
To read the first story in the series, "Post Super Cycle and Pandemic Strategies."
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