If Working Capital is Disappearing, What Should You Do? July 15, 2016
In the July 13 UNL Cornhusker Economics, Tina Barrett, executive director of Nebraska Farm Business, Inc., writes: "It seems just about every farm management topic/article/presentation is talking about working capital these days. We’ve heard experts talk about “Cash is King” for years but why is it really important?
"Working capital by definition, shows us how much of a “cushion” there is between the assets you plan to sell in the next 12 months and the debts you will owe in that same time. That includes your operating note, but it should also include the payments you will make on your term debt (equipment and land). So it’s easy to think that the more working capital you have, the better. So how much working capital do you need? It depends on your operation. $100,000 of working capital seems like a lot and it may be for an operation that grosses $200,000. But for an operation that grosses $10 million, $100,000 is not much working capital.
"To better define how much working capital is appropriate, we look to a ratio called Working Capital to Gross Revenue. This allows us to look at working capital more appropriately for each operation. So the first operation we used in the example with $200,000 of gross income would have a ratio of 50% ($100,000 of working capital/$200,000 of gross revenue). The second operation would have a ratio of 1% ($100,000 of working capital/$10,000,000 of gross revenue). A 1% cushion is not much. The industry standard set by the Farm Financial Council is 30% but opinions vary."
In the full article Barrett goes on to discuss three options for addressing working capital shortages:
- Increase net income.
- Refinance debt to move current debt to an intermediate or long term position.
- Sell assets to generate more cash.
See the July 13 Cornhusker Economics, Working Capital is Disappearing.