Road sign of volatility ahead.
March 17, 2017

Working Capital Is Like Oxygen

 |  By: Dairy Talk

By Jim Dickrell

As winter wanes and the buds of spring slowly emerge, a young man’s fancy turns to…working capital.

Ok. Maybe working capital isn’t the first thing that comes to mind as the weather warms, and machine sheds bustle with wrenches and grease guns prepping manure pumps and corn planters. But adequate working capital shouldn’t be far from mind because adequate amounts let you concentrate on these other tasks at hand.

The reverse is true as well, as Warren Buffett well knows: “Cash is like oxygen. When you don’t need it, you don’t notice it. When you do need it, it’s the only thing you think about.”

“In stressful times, working capital can be a lifesaver,” says David Coggins, chief banking officer with Investors Community Bank, Manitowoc, Wis. “And lack of working capital makes stress times even more stressful.”

Working capital, or liquidity, is the amount of cash and assets that can be converted to cash to meet current liabilities. For example, feed inventory (including haylage and corn silage) is often considered part of a farm’s liquidity.  But haylage or corn silage must first be fed to cows before it converts to cash, because it it’s sold, it usually sells at a discount to its true feed value. Corn grain, on the other, hand is typically more easily converted to cash.

So how much working capital do you need? There is no one-size-fits-all answer, says Coggins, because it depends on your cash flow, how leveraged you are and what your debt repayment obligations are. As a rule of thumb, lenders typically use 15% to 25% of annual revenue as a benchmark.  At $17 milk and a 24,000 lb herd average, that’s a range of $600 to $1,000 per cow.

“You may need to be as high as 35% in high-stress environments,” he says. What’s right for you depends on cash flow and cash needs, such as whether you do your own field work or rely on custom operators  to raise heifers, get crops planted or  feed harvested.

Not having working capital can be expensive, adds Matt Lange, a business consultant with AgStar Financial Services.  If a farm has $200 per cow in working capital and is depleting it a further $500, the farm will have to borrow $700 just to get back to a targeted working capital of $400.

Even at 5% interest, needing to borrow that $700 per cow can cost about $1.34/cwt per cow per month. For a 500-cow herd, that can add up to $8,000 per year in interest expense or close to $60,000 over seven years.  And that doesn’t even account for paying back the principal on the loan.

The message is clear: Having adequate working capital is critical in times of stress. In fact, in times of high stress, it might be the difference to business survival.

For more on building cash reserves and working capital, click here.