If Cash is King, is Working Capital the Queen? - How working capital is the difference between success and failure when it comes to primary producer operations

Growing up, I can always remember the early days of working paycheque to paycheque. Always thinking that next month I would be able to put some money aside (or more likely what night at the bar I could spend it at). It’s almost ironic that I ended up in primary producer agriculture; the one business where you can be a millionaire on paper, but still live worrying about next month’s bills.

Working capital on farms is not strong. The last numbers I reviewed in the industry show that over the last decade of strong commodity prices and profitability, most producers went backwards when it came to cash position. Many will blame the rising cost of production, the inflated equipment cost of capital, and increasing land prices as the main culprits. This might make me unpopular, but the truth is, working capital strength is primarily based on management. The decisions we make day-to-day have a much larger impact on the cash position of farms.

If you show an accountant a set of financial statements, the first measure they look at will be working capital. Most believe that earnings should be the biggest interest to a consultant, but most are wrong. With the volatility in farming, I expect to see profit every few years, but the true measure of the farm, and management, is how they run their working capital. This is also the greatest measure of future success, as a strong cash position allows farms to have a much higher expectation of their margins and profit in the coming years. Let me explain.

When you sell your grain

If you have ever read the journals of Dr. Dave Kohl, you will understand this point: “Do not let your ego get in the way of making marketing decisions, you must leave some money on the table.” This might seem counterproductive to profits, but the principle is, when it comes to grain marketing, you don’t have to try to hit the home runs. In baseball, home run hitters strike out considerably more than on-base players.

As it relates to grain marketing, working capital is, first and foremost, freedom. You can hold grain during down cycles, plan sales based on logistics rather than cash requirements, and sell into profits without always hitting market highs. Throughout my career, I have seen this type of marketing freedom create significant margin increases over competitors (in this case, other farms). If you have the cash position to be able to make sales when you want, then you run the game, not the other way around.

When you buy your inputs

If we have learned one thing over the last twelve months, it is that we are not in control of our own cost of production. The policy risk shown in the past year and its impact on the products we use has been eye-opening. From a single boat blocking a canal and backing up logistics for months, to a war raging across the Atlantic and limiting our ability to purchase fertilizer, the influence of external factors affecting farmers outside is significant.

Regarding working capital and crop inputs, the ability to purchase based on cycles can create drastic margin discrepancies. To put things into context, this past year our farm inputs more than doubled in value from the time we purchased our fertilizer and chemical last summer to when we prepared our year-end financial statements. To quantify this, if we had turned around and sold our inputs at market value, we would have had higher profits than many of the years we grew a crop. This example shows the power of purchasing freedom.

With that being said, many overlook logistics when it comes to crop inputs. Historically, we have always heard that a certain variety of canola seed would be sold out, or specific chemicals were limited in supply, only to find out that most times it was salesmanship. This year may have been the first time we saw logistics be affected when it came to crop inputs. Moving forward, at least in the short term, I believe we will continue to see this. Having the working capital to purchase early and lock in supply may very well be the differentiating factor when it comes to farms protecting themselves from these supply chain issues out of our control.

The current interest environment

I have very few farms that can play the “debt-free” card when it comes to financial strength. To be honest, I don’t want them to. In an environment where farms are seeing a return on assets or return on equity of greater than 10%, why would you want to remain debt-free? Even at current interest rates, you are leaving money on the table.

However, having working capital does lower your interest rate risk. Most farms have made the proper decision to restructure over the last few years and lock in low rates for the long term (I have never done so many interest-rate swaps and 10-year fixed rates at any other point in my career). This is a great method to reduce risk, but it does not fix the operating credit. Many farms utilize large operating credit, whether through banks or retailer financing, to put the crops in the ground. It is important to keep in mind that these lines are often based on prime rates, which are driven by the Bank of Canada.

By having strong working capital, you can make the decision to make sales earlier and repay the operating lines more quickly to reduce interest cost. This allows you to lower the overall financing costs of operations. Farms that do not have strong working capital often remain in their credit for the full term, which in turn will mean increased costs in the current market environment.

To be fully transparent, I don’t have many farms that do not utilize their full operating lines throughout the year. It comes with the territory of being growth-oriented, progressive, and having a high-risk, high-reward mindset. The misunderstanding comes when producers believe that their operating line is the same as working capital. The farms I run still have strong working capital, but the difference is they utilize their cash tightly so that they can earn a return on every dollar that they have available.

“If you are not maxing out the operating credit, are you farming hard enough?”

In Part 2 of this blog, we will cover the external perils that plague working capital on farms.