SW Financial Literacy
Working Capital vs. Cash Flow (Part 3)
Now that we have covered the basics of working capital (Part 1: Working Capital vs Cash Flow (farm640.com)) and cash flow (Part 2: Fixing Cash Flow (farm640.com)), how much WC should you use toward the down payment or how much should you finance on a purchase? (If you haven’t read Part 1 & Part 2, please read those for better context for Part 3.)
Part 3 can be considered more of an activity sheet than a newsletter. I have links to all types of tools to help you with your decision making. Read this and click on the links from your computer. These are the skills you need to master.
I assume if you are reading this, you have your balance sheet and cash flow each up-to-date. Compare your current WC position to my recommendation here (How to Get Financed Part 3: Capital – Farm640) and cash flow position here (How to Get Financed Part 2: Capacity – Farm640).
Where is your financial strength? Are you strong WC but tight on cash flow, vice versa, or balanced?
Now I want you to look at your financial trends (BS trend & CF trend). Which direction have you been moving the past 3 years? Maybe your WC is strong today but has been shrinking rapidly. Know which direction your financials are heading before moving on.
Finally, run purchase scenarios off your most recent balance sheet. (Balance Sheet + Scenarios – Farm640 pw=farm). Start with the minimum down payment allowed by your lender (probably 30-40%). Does your current ratio stay above 1.50:1? Where is your WC/acre? How tight has your cash flow gotten?
If WC is still meeting standard or at an acceptable level, you can start to play with the scenario by applying a larger down payment to the purchase and financing less. See how much the lower debt payments improve your CF.
Are you able to run a scenario that keeps your WC & CF above acceptable levels? You may have a workable deal. Keep adjusting to optimize your financial position with the purchase. Also, run scenarios at different purchase prices to see how high you can bid without compromising both WC and CF.
Do you see how all these tools come together to help you make strong financial decisions? You can’t just look at a balance sheet or cash flow to make decisions. Even the current year’s accurate information won’t tell you the whole story. Know your current financial position and history to help determine the best course of action.
What are your financial goals and where does your comfort level sit? Some feel better with a stronger cash position while others like a CF way above lending standards. That’s okay.
If the numbers are telling you ‘yes’ but your gut is telling you ‘no’, trust your gut. If your gut says ‘yes’, but the numbers say ‘no’, consult with your local lending or financial expert to make sure you aren’t missing something.
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.