This valuable question was posed to a panel of experts at the recent Mid-South Agricultural Finance Conference at the University of Tennessee at Martin. The panel to whom this question was posed consisted of Freddie Bernard of Purdue University, Steve Isaacs of University of Kentucky, my fellow officemate in graduate school at Cornell, Richard Brock, and of course, yours truly.
This intriguing question generated a wide range of responses from the panel. First, one must consider the producer’s goals; business, family and personal. Next, look at the current business position. If the business is near the stage of exit perhaps the financial losses and negative margins are not a good use of the excess working capital. If the business has demonstrated profitability in recent years, above the rate of inflation and interest rates on borrowed monies, then the use of working capital to bridge the negative income gap may be a wise use of the working capital excesses.
Other points that must be considered are why the business is in a position to require such an influx of working capital and how can it be strengthened. In other words, the panel of experts wanted to know whether the individual would make the necessary corrective actions to bring the business back to a profitable state. Tough choices have to be made concerning family living withdrawal reductions, machinery and equipment needs, capital expenditure priorities, and reduction of other costs such as, inputs and cash rents. Knowing the cost of production by sector and implementing a marketing and overall risk management programs is a high priority.
A special note to those who are examining the burn rate on working capital. To calculate, subtract current liabilities from current assets to derive working capital. Then, take the projected or actual losses and divide them into the working capital figure. This will result in the amount of time it takes to burn through your working capital. For example, if working capital is $500,000 and loses are $250,000 then the burn rate is 2 (or 2 years). If the resulting amount is less than or equal to one (or one year), your business will require immediate action on the aforementioned issues. Ideally, a business should have three years of burn rate in order to allow time for corrective actions.
Finally, it often takes a number of years to build working capital, the financial shock absorber, only to find it can be depleted rapidly. However, these are the realities of extreme cycles in agriculture that can place any good business person on an emotional roller coaster. Therefore, when contemplating the best use of working capital in a business, one must consider multiple factors, which requires a discerning perspective and willingness to change.