Storm clouds are building as American agriculture, specifically the grain sector, is entering phase one of the post-commodity super cycle downturn. One of the first signs of a downturn is buildup of machinery and equipment inventory on dealership lots. Used farm equipment will sell at 60¢ on a dollar and, in some cases, auctions will find “no bids.” Farm ground that is marginal due to lack of fertility, lack of water availability, or irregularly sloping fields will take landlord discounts. In phase one of the downturn, access to short-term operating credit will become an issue as some producers fail to meet existing loan covenants. Internal and external reviews by auditors and regulators may also lead to downgrading marginal credits. These are all macro signs being observed in some regions of the country that specialize in grain and row crops with few other alternative crops.
Moving to specific signs of a downturn in farm businesses, difficulty usually starts at the top of the balance sheet in current assets and liabilities. Failure to pay down operating lines of credit and a dramatic rise in accounts payable are leading indicators that there are not only profit issues, but cash flow issues in the business. My experience has taught me that lenders should not necessarily believe what they see on paper in this situation. Many open accounts payable go unreported, under-reported, or show their ugly heads in the form of credit card debt, so conduct due diligence.
Having split lines of credit is a behavior that often involves “robbing Peter to pay Paul.” Split lines of credit refer to having more than five different sources of institutional credit that are not credit lines. Breakdown of communication and the human behavior of “sticking their head in the sand” can also be a prelude to possible financial trauma ahead.
Selling capital assets such as land, machinery, and livestock was a strategy used in the 1980s to weather the downturn. However, keep in mind that selling productive assets scales back the operation’s income earning ability. Also, consult your tax advisor before selling capital assets to discuss any tax consequences that may arise.
Finally, the sale of exuberant assets acquired in favorable economic times, referred to as killer toys, can be a sign of financial stress. Unfortunately, these killer toys are often sold for less than $0.50 on a dollar during tight times. As the post-super cycle economic downturn progresses, tough adjustments will need to take place on farm and ranch operations, which can result in stronger businesses in the long run.