In Part 1 of this blog, we covered how working capital strength can benefit primary producer operations.
As an entrepreneur, I have always been drawn to the fact that I am in charge. Now, I don’t mean this in the sense of having an inflated ego, but rather in the sense that I am ultimately the one who gets to make the decisions that influence the future of my business. It brings a higher sense of pride than when I was in public practice accounting and had to follow the rulebook of those before me. In other words, when we win, I am not riding the bench, per se.
However, when we lose it is also on me.
In the first part of this blog, I mentioned that working capital is a “management decision”.” Many will believe that external factors like weather, markets, and geopolitical events are the main drivers of cash position, but the truth is, the decisions we make as farm managers can mitigate many external factors.
1. Cost of production
It is expensive to be in farming today. Due to inflation and significant geopolitical occurrences this year, we will see the highest cost of production on farms ever. For most, this will have a significant effect on the working capital of farms as it is taking more cash and credit to put the same crop in. The inputs we buy have doubled in price, the cost of fuel has sky-rocketed, minimum wage and labour costs are increasing, and let’s not get started on the cost of equipment. If you scroll through social media today, all of these will come up on your feed numerous times.
Farms this year will utilize more credit than they have probably ever required in the past. This will drive down working capital right up until Harvest. Even with the current dip in market prices, we are about to see the highest gross revenues on farms over the last decade. If you have calculated your gross revenue numbers, you will see that the percentage increase in revenue far outweighs the percentage increase in cost of production. This means that even with a rising cost of production, primary producers are about to experience some of the largest profit potential we have ever seen.
2. External risk factors
So, what about those that are seeing drought this year? Or what happens when commodity prices drop quicker than expenditures in the future? The one rule I apply with most of my progressive and high-risk farms is to play hard and insure hard. If you are going to follow the rising cost of production by expanding, buying equipment, or pushing inputs, then insurance will become a fixed cost on your income statement. Let’s call it the cost of doing business. For many, insurance is a dirty word. For the farms pushing hard, it is a lifeboat.
The reason that I am a large proponent of insurance is that the programs are based on your own numbers. You oversee your own domain. Your yield guarantees are based on your ten-year historical outcomes. The margins for private or government programs are based on your marketing, production, and purchase history. If you have made strong financial and management decisions in the past, you now have a bulletproof strategy using insurance. Furthermore, with these changes, you now have a three-to-five-year runway before poor outcomes make insurance unusable (between private and government planning on insurance programs).
3. Expansion and growth costs
The current belief is that with rising interest costs, land values and consolidation will begin to soften. I don’t believe this is true. Over the last few years, with the lowest interest rates in decades, most of the farms I work with have locked in rates and opened lines of credit for expansion. This means that many farms have ten-year rates already locked in (some at sub-2.5%) and open capital ready to make purchases of land or equipment. The truth is, I still see competition pushing land prices up in Western Canada.
So, why does growth have significant effects on working capital? The main reason is that farms loosen the “war chest” and start spending short-term cash on long-term assets. An auger here or there, an extra bin during harvest, a small tractor for yard maintenance. On most farms, the small assets paid out of working capital often are what starts to hinder the farm’s overall cash position. Therefore, over the last few years, I have not been afraid of long-term debt. Push the assets out further, conserve cash and working capital, and take advantage of opportunities on land.
The second reason is operations. If your cost of production is $450 per acre, and you expand 2,000 acres, you now need $900K of additional operating credit (or you use your current working capital). Therefore, your relationship with your banker is important. It is not often the long-term debt that gets hurt during proper expansion, it is the short-term operating credit that is required.
There are numerous reasons that working capital on farms continues to diminish. As this occurs, the gap between high-producing farms and low-producing farms continues to widen. As an industry, we need to feed nine billion people over the next decade, so as a group we all need to be stronger. As mentioned before, working capital is the first measure of strength that should be considered.
If cash is king, is working capital the queen? In my assessment, working capital is the entire kingdom.