SW Financial Literacy
Working Capital vs. Cash Flow (Part 2)
On the farm, you always need to be balancing your working capital vs. cash flow position. Tipping the balance too far in either direction can prevent you from taking part in new opportunities as a best case scenario or can make you have to sell a farm to fix the problem as worse case.
That is why it is important to understand how each is impacted by the choices you make. Educate yourself now, so you can maintain the balance while growing.
Here is a link to Part 1: Working Capital vs Cash Flow (farm640.com)
Now for Part 2.
Pros of Strong CF
A strong cash flow means you are making money!
This is fun to see and healthy for your operation. A strong CF builds your working capital position and is the engine that makes everything go.
You have room to make new investments and try new things. Maybe you are short on labor. You can complete equipment or facility upgrades (through financing) to become more efficient. When the money is flowing, life is easier.
With a strong CF you can consider taking on more expensive rental ground to spread out other expenses over more acres. I’ve also seen individuals start ag-adjacent businesses and experiment with different opportunities.
The strong CF gives you room to grow the operation with debt or restructure your balance sheet to improve the WC position.
Cons of Low CF
Low CF makes for very little return to show for your years’ worth of work and can sometimes be outside of your control.
If negative, it starts to eat into your WC, making you illiquid and creating doubt about your ability to operate in the future. Negative CF can snowball into a ‘for sale sign’. This is why it is so important to identify the cause of low CF as soon as possible to make adjustments and rectify your situation.
When CF is tight, banks say ‘no’. There is not room to fix a WC mistake through debt, even if you have strong equity in your land.
The focus of your operation when dealing with low CF is no longer growth, but identifying and fixing the problem.
Causes of Low CF
Here are the most common reasons for CF problems:
Low commodity prices or poor yields
Too many debt payments (land, equipment, & personal)
High living expenses
Unchecked, high crop input expenses
Poor marketing or selling at the bottom
Unexpected expenses like repairs, medical, and divorce
How to Fix CF
Did you notice under ‘Causes’ I didn’t say, ‘bad luck’? There can be multiple years of most of the above occurring which feel random and unlucky, but this is not luck.
If you have poor yields, make adjustments to your insurance plan, fertility, weed control, and crop genetics.
If commodity prices are low, work with a marketer to create price floors and a plan to sell into rallies.
If debt payments are too high and you have strong WC, pay off smaller debts to reduce debt obligations each year.
If equipment is too expensive, partner with neighbors to decrease expense labor and share equipment.
If inputs are too high, get quotes from competing suppliers.
If the side business or high rent is sucking all the income from the rest of the operation, get rid of them.
If living expenses are the problem sell your boat, cancel the cable, don’t book a vacation and start a budget.
If you do everything listed above, I can promise your ‘luck’ will change for the better.
Additional items to consider when trying to improve your CF:
Generate additional income. Bonus points if this is a W-2 wage which provides health insurance. This is twice as impactful as it improves income and lowers expenses.
Don’t add new debt to your balance sheet. Instead of trading up or replacing the debt, let the debt payments disappear to improve your bottom line.
Restructure debt to longer terms, which reduces your annual debt obligations. (Be very careful with this. You don’t want to move low interest rate debt to a higher rate. You also don’t want to pay for something twice by moving it to a longer term and paying all that extra interest. This is a lever that can probably only be pulled once per down cycle and can slow your recovery.)
What should you do on a purchase?
Should you use up more WC or cut into your CF for the purchase? Find out next week in the finale, Part 3.
Thanks, and have a great day!
Grant
All views expressed on this site are my own and do not represent the opinions of any entity whatsoever with which I have been, am now, or will be affiliated. Information provided is authentic to the best of my knowledge, and as such, is prone to errors and the absence of key details. The content of this blog is for entertainment and informative purposes and should not be seen as professional advice to finances or any other field.