Playing the House’s Money – Indicators that your farm is working for the bank
Think of the farm as a casino in Vegas. You have been sitting in the same cab for hours; you don’t know what time it is, the odds are always stacked against you, and the house never loses. And don’t forget about the credit marker you just took to play another hand. If the hair on your arm just stood up, you may be a farmer.
Agriculture is a highly capital-intensive industry that requires significant financing for operations, capital investment, and real estate. Every year I see farms continually get new credit markers to make sure the house of cards does not fall. But when this happens, you are always playing with the house’s money. And the one thing I have learned in life: the house always collects.
As a primary producer, the following are the top five indicators that you may be working for the bank.
Debt Payments Are Killing Free Cash
In agriculture, we work off two different accounting perspectives: accrual and cash. Accrual identifies your true profitability and also ties into your balance sheet and the true growth of your investment over time. Cash identifies whether the farm is economically feasible and has the solvency and liquidity to continue to operate. Both are important in their own way. They forget to tell you that you can be profitable and broke at the same time.
Our latest benchmarks of progressive and growth-oriented operations identified that greater than 76% of total cash earnings (or EBITDA) go into debt repayment on land, capital, and infrastructure. Another 10% or more goes into personal living expenses and drawings to invest off-farm. This only leaves around 14% of total cash earnings to reinvest into non-funded capital purchases or working capital, a very low margin for free cash flow.
The Farm Cannot Have a Down Year
When I started consulting, I always enjoyed getting yield estimates from producers. I would look at the ten year history from crop insurance, then see a 10% bump on those yields by producers for what they were “shooting” for. Now, later in my career, I don’t even ask a lot of the time. Send me your insurance; we can discuss the “new norm” later.
If the projection requires perfection, you already busted the hand. I have seen farms create projections solely to show they meet their banking covenants. A bushel here, or a $1 there, and all of a sudden we can hit our lending requirements. Maybe we might even have enough room to roll a piece of equipment or two. This works until Mother Nature or a war across the world decides it doesn’t. And let’s not talk about the ability to deliver and hit cash flow requirements. When was the last time we saw a railway strike or an elevator stop deliveries? Good thing we don’t live in a province that hits -40 degrees very often.
Borrowing From Peter to Pay Paul
The industry calls it “living off of grandpa’s equity”. We call it repeat restructuring. Many producers call it living in our means. When I started public speaking, I would often remind producers that they are the 1% richest entrepreneurs in Canada based on their net worth. The one thing I shouldn’t have left out: you have to sell to realize it. Equity rich, cash poor, is a saying in agriculture for a reason.
If you have to continually borrow to fund operations, cover long-term obligations, and cover your personal cost of living, you are already behind in the hand. I have always found it interesting when producers treat operating lines of credit like a bank account. That personal house mortgage, the boat payment, the trip on your credit card – by covering those obligations with your operating credit, you are essentially borrowing twice. One restructure blames the weather; two restructures blame management.
You Farm For the Bank
Have you ever let a call from the bank go to voicemail? If yes, you may farm for the bank. Have you ever sold grain when you didn’t want to so you could pay out a line of credit? If yes, you may farm for the bank. Have you ever passed on low cost fertilizer when it would have created a positive margin? If yes, you may farm for the bank.
The last sign of financial fatigue is when every decision revolves around available credit. This does not mean that as a farmer you should not utilize short-term credit during the growing season. In fact, I only have 2% of clients who are in a place where they don’t require bank or retail funding. This discussion is about whether the funding is now dictating your financial decisions as a manager. The lowest grain prices are historically in harvest, February, and March in Western Canada. The reason: the deadlines on retail lines of credit are due in those same months.
Agriculture is no different than other businesses. It runs on a cash conversion cycle that requires the farm to make sales and pay bills to adequately cover its short and long-term financial obligations. The slight variance is that a farm only has one inventory cycle during that time, may have three different growing seasons on an operating note, and requires some of the largest capital requirements in infrastructure and equipment.
Back to that age-old question in farming: do you fold or do you double down? Only your farm can answer that.
