Over the years, many of you have heard me discuss the importance of financial liquidity. In the current times of extreme volatility and global uncertainty, the rules on liquidity have definitely changed. The other day during a videoconference with producers in six locations, Mike Hosterman, an AgChoice Farm Credit business consultant who has many years of experience working with ag customers, discussed a new twist on liquidity.
Mike stated that in many ways liquidity is a measure of flexibility. It is your cash or near cash reserve. It is also your borrowing reserve. What should you do if you have some extra liquidity, or a year when liquidity can easily be built up?
- First, pay down accounts payable, whether it is for fertilizer, seed or repairs. This is a top priority to maintain strong relationships with suppliers.
- Next, he suggested retiring the operating line of credit or paying it down to zero to start with a clean slate for the next period.
- These two strategies are followed by retiring excessive debt, typically short and intermediate term debt.
Mike indicated that building liquidity requires a high degree of discipline to avoid “wants” and focus on “needs.” Of course, excess liquidity can be used to build cash in the bank or a future payment fund for Farm Credit. This cash can be used not only as a financial parachute in difficult times, but also as “dry powder” if opportunities arise. Mike was clear to state that liquidity should be allocated toward those parts of the business that will improve profitability and efficiency.
Mike recommended a liquidity goal equal to a 2:1 current ratio, or $700/dairy cow. Other metrics for financial liquidity include 33% of revenue or costs, or $200-300/acre of farm crops.
Finally, liquidity is important in the household budget. Maintain a liquidity reserve of at least four to eight months’ worth of living expenses for the hiccups that can occur in family situations.
By the way, videoconferences are a fantastic learning medium, even for day-long seminars with facilitated exercises at each location. Hats off to AgChoice for being leaders in this educational delivery method for seasoned producers as well as young farmers!
Editor’s note: Dave Kohl, Corn & Soybean Digest trends editor, is an ag economist specializing in business management and ag finance. He recently retired from Virginia Tech, but continues to conduct applied research and travel extensively in the U.S. and Canada, teaching ag and banking seminars and speaking to producer and agribusiness groups. He can be reached at [email protected]