Working capital is the cash available to a business to meet its short-term financial obligations. The amount of a company’s working capital is calculated by subtracting current liabilities from current assets. Current assets include cash, accounts receivable, grain and market livestock inventory, prepaid expenses (for example, feed, fertilizer and seed inventory), and investments in growing crops. Current liabilities include accounts payable, unpaid taxes, accrued liabilities including accrued interest, operating lines of credit and principal repayments due in the coming year on longer-term borrowings .
Working capital provides the short-term financial reserves a business needs to respond quickly to financial stress and take advantage of opportunities. It provides protection against financial downturns that could affect the farm’s ability to purchase inputs, pay off debts or follow through on its marketing plan. It also provides the financial resources to quickly take advantage of opportunities that may develop (eg, renting additional land, buying land, adding a family member to the operation).
This article discusses recent working capital trends and working capital differences between operations, and provides working capital benchmarks. Data from USDA-ERS as well as Minnesota’s Center for Farm Financial Management is used.
Working capital benchmarks
How much working capital does a farm need? The answer to this question depends on both the risk and size characteristics of the operation and the volatility of the business climate. In an unstable business climate and when a farm engages in ventures that have relatively higher variability in net returns, more working capital is needed. Large farms also need more working capital, so it is best to determine the amount of the working capital buffer relative to gross income, value of farm production, or total expenses. Working capital/gross income, working capital/value of agricultural production, or working capital/total expense ratios above 0.35 are thresholds commonly used by financial analysts and would be considered an adequate level of working capital for face a downturn of one or two years. . When working capital ratios fall below 0.20, a farm may struggle to repay loans. An individual can also measure working capital adequacy using the current ratio, which is calculated by dividing current assets by current liabilities. A current ratio greater than 2.0 is a commonly used threshold. When the current ratio falls below 1.0, a company does not have enough current assets to cover its current liabilities.
Working capital trends
Figure 1 illustrates the trend of working capital in the U.S. agricultural sector since 2012. Working capital grew from $165 billion in 2012 to an estimated $65 billion in 2016, then increased to $96 billion in 2021. Working capital is expected to be approximately $93 billion in 2022, down 3.3% from the 2021 level.
The working capital to gross revenue ratio for the US agricultural sector since 2009 is shown in Figure 2. From 2009 to 2014, the working capital to gross revenue ratio ranged from 0.22 in 2013 to 0.43 in 2010. The ratio was above the threshold of 0.35 in 2010. and 2012. Since 2015, the working capital/gross income ratio has been below 0.20. The projected ratio for 2022 is 0.18, which is below 0.20, indicating that some farms may have difficulty repaying their loans.
Figure 3 illustrates the average current ratio for the US agricultural sector since 2009. The current ratio was above 2.0 from 2009 to 2014. The current ratio bottomed out in 2016 at 1.59. As of 2020, the current ratio ranges from 1.85 to 1.89.
Obviously, the US data is very aggregated. FINBIN data summarized by the Center for Farm Financial Management at the University of Minnesota can be used to provide a more regional view of working capital trends over the past 10 years (i.e. 2012 to 2021 ). The average working capital to gross revenue ratio using FINBIN data increased from 0.431 in 2012 to 0.256 in 2018 and 2019, then increased to 0.326 in 2020 and 0.406 in 2021. Similarly, the average current ratio increased from 2.65 in 2012 to 1.58. in 2018. The average ratio in 2019 increased to 1.60, then to 1.97 in 2020 and to 2.43 in 2021. The strong net farm income recorded in 2021 improved liquidity to levels not seen since 2012.
Difference in working capital between farms
The ratio of working capital to gross revenue as well as other measures of liquidity vary widely from farm to farm. Using FINBIN data summarized by the Center for Farm Financial Management at the University of Minnesota, the median ratio of working capital to gross income in 2021 was 0.367 or 36.7%. About half of the farms had a ratio above 0.35. However, about one-third of farms had a ratio below 0.20. Of the farms that had a ratio below 0.20, about half of this group had a negative ratio, indicating that their current liabilities exceeded their current assets.
The current median ratio of farms in the FINBIN database was 2.32 in 2021. More than half of farms had a ratio above 2.0. About 15% of farms had a current ratio below 1.0.
The FINBIN results discussed above illustrate the huge differences in liquidity between holdings. Farms with lower levels of cash should be very careful when taking on more debt and when investing in fixed assets such as machinery, buildings and land.
This article has provided working capital benchmarks and discussed working capital trends and working capital differences between operations. Even with high net farm income in 2021, there are still farms with very low cash position (i.e. current ratio below 1.0 and/or working capital to gross income ratio below to 0.20). When working capital to gross income is less than 0.20 and/or the current ratio is less than 1.0, operations will have difficulty repaying loans. Equally important, when cash becomes very tight, farms have very little flexibility in terms of their input purchases or the timing of their produce sales. In this situation, it also becomes increasingly difficult to borrow funds to replace machinery and equipment, or to rent or buy land.