Ideally working capital is positive, but for many in ag it’s not because of equipment and land investments. Learn strategies to improve.
It’s been a rough two years in agriculture. Commodity prices have declined, input prices are up, and working capital has taken a major hit. The blow to production ag predicted at the end of 2019 and halted by COVID-19 USDA payments, PPP loans, and strong commodity prices looks like it may come to fruition this time.
A working capital agricultural case study
During December planning meetings, I had a discussion with a young couple who had tried to purchase a farm in the fall. They have a lucrative off-farm business producing plenty of supplemental income. They had paid cash for a new machine shed this year.
However, their lender turned them down — their balance sheet wasn’t strong enough. They didn’t understand the decision. Their income was great, they had no problem making payments, and were upset they were turned down.
What is working capital?
What was the lender looking for? He was concerned with their working capital. Working capital is calculated by taking your current assets (cash, inventory, accounts receivable, growing crops, livestock) and subtracting your current liabilities (accounts payable, line of credit, term debt due in the next 12 months).
Ideally this is a positive number, but for many in ag businesses it’s not because of the size of the investment in equipment and land. Some ask why it’s important — it’s just geography on a balance sheet. Some argue they have plenty of land to secure their debt, so what’s the difference.
The problem is term debt and lots of real estate won’t get you through today’s lean times. You can’t spend dirt and the historic position of those in production ag to be land/equipment rich and cash poor becomes a problem.
Many producers are looking at rolling over significant amounts of operating loans into term debt. Lenders obviously become more concerned when this occurs. This may be a short-term solution, but not a long-term strategy and term debt payments themselves can quickly become unruly. Unfortunately, the reason for lean working capital is often the result of income tax management tactics.
What can be done to make 2026 the year of working capital in agriculture?
- Monitor family living and don’t use your operating line to fund it.
- Evaluate equipment purchases fully. Repairs might be expensive, but they also may provide less of a cash outlay allowing producers to get through this cycle. If you do buy, look for dealer financing programs with more favorable rates and terms.
- Instead of using your lender’s line of credit, look for vendor financing programs that are often at 0%.
- Use the information provided by your soil tests. Can you cut back on fertilizer this year? If you apply at traditional rates, will the projected difference in yield justify the cost?
- Consider different strategies when filing income tax returns in March and April. Are you better off paying more or less taxes this year to hold onto more cash in the future? For example, if you planned to take Section 179 on a tractor this year to reduce taxes to the 12% bracket, are you actually better off to pay at 22%, save some depreciation for the future and not feel like you “have” to buy a piece of equipment to keep up with the tax collector in 2026?
- Look at high cash rent farms. Bigger doesn’t always equal more profit — and profit is what pays the bills.
- Communicate with your lender early and often.
How CLA can help agriculture with working capital
The lessons learned and changes made in this cycle need to be transitioned into operations when the good times return, as well. Consider when the upswing cycle comes how you’re going to re-vamp your operation.
Will decisions be driven by income taxes or by reducing debt and stockpiling cash to allow for more freedom when the rainy days return? A farmer said to me just yesterday, “It’s always better to make a decision because you want to and not because someone tells you that you have to.”
What happened with the couple trying to purchase the farm? They took our conversation seriously and are using their off-farm income to put pressure on their line of credit this year and to improve their chances for future loans.