The difference between success and failure in business is how well that business is able to manage risk. This special issue of The Progressive Farmer provides ideas for managing risk in one of the most volatile times ever in agriculture.

Cash Is King
Greater liquidity provides you with security and leverage to negotiate better deals.
By Elizabeth Williams

Having cash on hand gives a grower newfound leverage, Bachman says. "If the fertilizer dealer says he'll give you a 20% discount but he needs the money now, you can write him a check. You don't have to go to the bank and delay five days waiting for approval. It puts the ball game in your hands to negotiate a good deal."

Higher risk. Like Bachman, lenders, accountants and economists see the wisdom in building a rainy day fund rather than reinvesting all your profits in capital items like land, grain storage or equipment now. With huge swings in commodity prices and higher input costs, "the risk meter is being turned up for both you and the bank that finances you," says Denny Everson, president of agribusiness for First Dakota National Bank in Yankton, S.D., and former chairman of the American Bankers Association's Ag and Rural Banking Committee.

Higher cash rents and input costs mean operating lines at many farms are up at least 50% or more in recent years, Everson notes. Adding to that tab is the fact that with fewer cash forward contracts at grain elevators, farm operators must now shoulder more marketing risk, possibly straining their cash flow to adequately hedge their prices.

Plainfield, Iowa, grain producers Stan and Karmen Mehmen and son Kyle have taken that warning to heart. "We need twice as much working capital now to be in the same financial health as last year," says Karmen. "And it's a challenge. We started buying 2009 crop inputs this past July and still had some '07 crop to deliver in September. Not every lender is willing to extend three years' lines of credit."

Technically, "working capital" means current assets minus current liabilities. In other words, it is your cash on hand plus the assets you would typically sell in the next 12 months minus anything you have to pay in the next 12 months.

Omaha-based Farm Credit Services of America (FCS) studied data from 72,000 customers recently and found which financial information was "most predictive of performance." Its finding: No. 1 was level of working capital. Second was ownership equity, and third was FCS's internal risk rating system.

"We were surprised cash flow or net income didn't even make the top five," notes FCS CEO Doug Stark. "Also, our analysis showed the larger the operation (strictly dependent on ag income), the more important working capital was to its success." Farms with non-farm income did not need as much working capital.

How much is enough? Lenders will take a sharp look at your working capital when assessing your credit risk this winter. And they'll likely increase reserve requirements across the board, farm lenders and consultants say. Those financial standards vary by enterprise, with highly volatile markets like feeder cattle or pigs demanding the most cushion.

"For the past 15 to 20 years, we've said row crop farmers need to have at least 15% of their revenue in working capital as an adequate cushion, but that has changed," says Allen Lash with AgriSolutions, an agricultural consulting firm in Brighton, Ill. "Today's crop producer needs at least 20% of his total revenue set aside as working capital."

Lash gives this example: Five years ago, if you had 180-bushel corn at $2.50 and 45-bushel soybeans at $6.50, your total revenue for corn was $450 per acre and $300 per acre for soybeans. With a 50/50 rotation, you averaged $375 per acre in revenue, so 15% of that would be $56 per acre needed for working capital. (See table.)

Now let's say you produce 200-bushel corn at $5 per bushel ($1,000 revenue) and 50-bushel soybeans at $12 ($600 revenue). Your total revenue would average $800 per acre. In a less volatile world, you would need to set aside $120 (15%) per acre for working capital. But in this more extreme market, you need to have at least $160 per acre in working capital, Lash explains. That's almost three times the amount per acre you needed only five years earlier.

Why do you need so much liquidity? "Because prices can fall as fast as they go up," says Lash. "We are in a very volatile economy. There is volatility in commodity prices and input costs; there is volatility on input suppliers staying in business; there is volatility on banks. When there is volatility everywhere, cash is king," Lash notes.

To watch a rebroadcast of “How to Grow Your Credit Line and Still Sleep Nights” with consultant Allen Lash and South Dakota banker Denny Everson, and what to do about the financial fallout with ag consultant Dave Kohl, go to about.dtnprogressivefarmer.com/webinars