One could almost bet odds that sometime in the next five years most every commodity is going to be challenged by a liquidity lag. A liquidity lag occurs when prices received and revenue decline faster than both fixed and variable costs.
Case in point: the cost of inputs such as feed, fertilizer and fuel will generally decline slower relative to prices as supply and demand adjust lower on the input side. The result will be a cash-flow shortage created by negative profits. Usually, it requires a year or two before the negative returns impact the ability of the business to meet expenses and financial obligations.
On the fixed cost side, contracts on cash rents also take time to adjust as both the lessor and property owners make a determination of whether the adjustment is a short- or long-run trend.
A producer needs to build working capital, particularly during the profitable years. The working capital reserve should exceed 10%, but ideally exceed 25% of expenses. Next, pay all account payables, and possibly prepay principal focusing on debt with the higher interest rates. While these strategies do not guarantee success, they do provide cushion to mitigate the short-run economic downturn.
Editor’s note: Dave Kohl, The Corn And 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].