Better business skills will help define producers of the future: Knuth09/28/2017 | Economics
By Aaron Putze, APR
Being a better farmer starts with being a better business person and that begins with understanding working capital and knowing your costs of production.
This ag economics refresher was offered by Farm Credit Services of America Sr. Vice President Jim Knuth at a meeting of young farmers hosted by the Iowa Soybean Association Sept. 19 in Ankeny.
“Past generations got by with being a good producer,” Knuth said. “But as young farmers, you’ll need to raise the bar because you’re competing against the world. More young producers are better educated and tend to be creative, innovative and entrepreneurial. You will need to be, too.”
Knuth said working capital – or current assets over liabilities – is the liquidity that farmers need to manage the volatility that comes with production agriculture.
“It’s hard to run a business without working capital,” Knuth said. “This is not an agricultural principle but a business principle. Working capital is your balance sheet risk management. Having adequate liquidity helps you make better business decisions versus having to over-react to short term cash needs.”
Current assets are a critical component of working capital. Examples include cash, savings, accounts receivable, grain on hand, cattle in the feedlot or animal inventory. In other words, current assets are possessions that can be converted into cash within a year. Current liabilities are bills due this year including interest expense and CMLTD (current maturities of long term debt).
Knuth said opinions vary about the amount of working capital to have on hand but the standard response is $150-$200 an acre for grain production agriculture.
“It seems like a lot but look how much we’ve lost the last two or three years?” he asked.
To help build working capital, Knuth urged the young farmers to exchange their time and skills for payments to provide a steadier cash flow. Examples include custom farming, grain hauling, spraying or contract livestock production. He also recommended diversifying revenue streams rather than waiting all year hoping yields and price will be sufficient.
“Remember, working capital is part of your equity,” he said. “But it is different than long-term equity items like land. You can’t write a check off your land.
“Understanding the importance of having ample working capital will make you a better business person and will allow you to make sound business decisions,” Knuth added.
Another commonality among savvy operators is knowing the cost of doing business.
“When you think about agricultural finance, think about the ‘PER concept,’” Knuth said. “Examples are working capital per acre, debt per acre and cost per acre. When we get our customers to think per pig space, per head of cattle or per acre, they get a better handle on their costs. Economics and ag finance numbers are always per-something.
“Don’t make finance any more complicated than it has to be,” he added. “A lot of financing is common sense stuff. However, if you want to be a better business person, you need to know every cost, period.”
Additional financial advice provided by Knuth:
- Know amortization, or the term or length of a loan. It’s the biggest driver of repayment of debt and cash flow, Knuth said. “When we talk to our borrowers about getting their cost down and reconciling their cash flow during these tough economic times, we talk about amortization. Our debt structure, our balance sheets, our loans are not always appropriate, especially for today’s margins.”
- On a related topic, keeping an interest rate associated with a loan term that one can no longer afford is a poor business decision because it will deplete cash reserves. “By keeping an interest rate that’s unaffordable, you’re draining liquidity and working capital. Interest rates are not the primary driver of payments these days – the amount of debt and the amortization of the debt are.”
- Hope is not a strategy when it comes to financial planning. “We have many customers who have proactively addressed this cycle and their economic situation and we have a few who are just trying to ride it out,” Knuth said. “Don’t ride it out. Guttin’ it out is not a business plan. If you want to be a better business person, be proactive with your adjustments and decision making.”
- Know your family living costs. “Too often, they get lumped into ‘miscellaneous expenses.’ You need to be better than that,” Knuth said. One way to get a handle on family living costs is for farmers to have a separate account and write themselves a check every month to cover living expenses. “Nobody magically pays your bills. Family living costs are one of those unspoken, awkward conversations in agriculture but they don’t have to be. To successfully manage your business costs, you need to know your family living costs too. Understand them and manage them if necessary.”
- Don’t go too hog wild during the good times. “That way, it doesn’t take as much adjustment during the down times,” Knuth said. “The reality is – high margins never last forever.”
- Finally, be sure to negotiate costs. “As a young farmer, you need someone to share the risk with you because you don’t have a lot of working capital,” Knuth said. “You’d be surprised how many land owners understand this principle of economics. So, ask them to work with you including crop sharing or flex leasing.”
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