With today’s elongated economic reset, questions about burn rates with various commodities are increasingly frequent. On a recent webcast with over 1300 agricultural lenders, one participant asked, “Would the burn rate calculation for working capital apply uniformly to both a dairy and a crop farmer?” Well, the short answer is, “it depends.”
Before exploring the longer answer, it is important to start with the right number. To calculate burn rate on working capital divide losses (cash flow or profits) into net working capital.For example, if a producer has $300,000 in working capital and $100,000 in losses, the producer’s burn rate is 3, or three years.
In response to the lender, typically dairy producers carry less working capital compared to a crop producer who has considerably more current assets in inventory. The dairy producer also receives a monthly or bimonthly stream of revenue through milk production. Because of that revenue stream, some argue that working capital burn rates on dairy farms can be lower than grain farms, which in some cases is true. In the grain and crop sectors, a burn rate of three years is considered low risk, where any rate under one year is considered high risk. In fact, regardless of the enterprise or agricultural sector, a working capital burn rate under 1 (one year) indicates a sense of urgency. Because of the revenue stream, an acceptable working capital burn rate for a dairy business may be one to two years, yet other factors to consider are the quality of current assets, whether the receivables are collectible, the quality of inventory, and amount of cash. Additionally, if one has crops growing field, are they covered by insurance and at what levels?
When considering the best burn rate on working capital for a particular enterprise, take the balanced approach to credit and financial analysis. In other words, what are the surrounding factors, trends and numbers aside from just profit margin and cash flow? For example, if of profits and cash flows are negative, which is currently the case for many, the next level defense is working capital. If a producer burns through working capital, the final level of resilience is core equity or excess equity, most likely in land. Thus, losses could be divided into the core equity. For example $100,000 in losses into $600,000 in excess land equity calculates to a six year burn rate.Especially in loss situations, knowing the burn rate at various levels on the balance sheet is a prudent practice, as well as an advantage in determining options with your lender.
In conclusion, the answer is that yes, rates for different enterprises may differ, but not simply according to the type of enterprise. Critical questions, observations and examinations must take place to determine the best burn rate for each individual business, and to preserve liquidity and wealth on the balance sheet for the long term.