BROADCASTER ARCHIVES

The Capital Factor in Farm Business Management
By Amber Bennett

This article was printed in the March/April 2010 issue of the Organic Broadcaster, published by the Midwest Organic and Sustainable Education Service.

For most farm businesses, capital is not an infinite resource. Each farm business has a specified amount of capital and a unique blend of capital allocation, based upon enterprise type, operation size, investing and spending habits, profit objectives, and future plans. In this article we will explore the second ‘C’ of the ‘Five C’s of Credit’- capital. Capital is an important area to assess based upon the farm business’ past financial performance and its future plans. While agricultural lenders typically analyze numerous ratios and indicators related to capital, based upon the nature of the farming operation and the credit request at hand, this discussion will focus on capital decisions as it relates to farm business management from a practical, profit-driven perspective.

1. Periodic Financials Statements- It is essential to have a good record-keeping system and to prepare regular financial statements, also known as balance sheets. Balance sheets should typically be prepared on an annual basis or more often such as quarterly or monthly, depending upon the nature of the operation. These statements allow a farm financial manager to monitor the unit’s overall financial position, to examine trends- including potential strengths and weaknesses, and to make informed decisions regarding capital resource allocation.


2. Working Capital- It is important for a farm business to build and maintain an adequate level of working capital. Working capital is generally defined as cash and current assets that will be converted to cash within a 12 month period minus any payables and liabilities that require repayment within the next 12 months. The last two years have proven to be a very challenging time for most areas of agriculture, given volatile commodity prices and rising input costs. In volatile times cash is truly ‘king’. Strong working capital levels allow a farm business to weather adversity and volatility, to pay down debt ahead of schedule, to expand or diversify the business, and to allow greater flexibility in overall decision-making. This is why it is so important for a farm business to build liquidity reserves during good times.


3. Debt & Leverage- As the old saying goes, sometimes ‘It takes money to make money’. Investing and borrowing decisions require the examination of many factors, including capital replacement or expansion needs, future plans for the business- phase down or get bigger, specialize or diversify, operational efficiencies, profit opportunities, and so forth. As another old saying goes, ‘Too much of a good thing can be a bad thing’. Thus, each unit has a debt threshold in which too much debt will render the unit unable to generate a profit and repay the debt. Thus, whenever additional debt is considered, it is wise for a farm financial manager to consult with the farm’s other key managers and a trusted financial advisor such as the farm’s lender to assist with a cost and benefit analysis of a proposed capital purchase and the subsequent debt load.


4. Opportunity Costs- When considering capital allocation, it is prudent to not only examine the costs and benefits of a proposed capital purchase but to also analyze the ‘opportunity cost’ of the decision. In other words, consider what opportunities the farm business will forego due to the proposed purchase. For example, if the Jones Farm wishes to expand its land base and buy the neighboring 150 acre farm, it will tie up some of its working capital for the down-payment, incur long-term debt to finance the purchase, and increase its interest expenses and principal repayment obligations for the next several years. However, if the Jones Farm does not buy this parcel of land, what other investing opportunities might come into play over the next several years that would provide even greater opportunities for the business to fulfill its long-term objectives and increase overall profitability? The moral of the story is that every capital purchase decision has a trade-off known as an opportunity cost that must be considered.


5. ‘Plan B’- Most capital purchase decisions are ones that will impact an operation for several years. Looking at the big picture, a farm manager should analyze various scenarios and determine appropriate alternatives for potentially reversing or modifying a past purchase decision, based upon potential market and operational risks, changing business objectives, and future plans. Consideration should be given to plans for enterprise diversification, expansion, bringing in the next generation of family into the business, accommodating the exit or retirement of some family members, and unexpected scenarios such as death, divorce, disability, and dissolution.

Capital asset management is a challenging job for the successful farm business manager. It can be a very rewarding job, as well-planned decisions propel greater operational efficiencies and increased profitability for the farm business. For the manager-owner, it can provide a fulfilling career and a potential farm business legacy for future generations to enjoy.

Amber Bennett is Vice President- Farm & Home at Badgerland Financial, serving farmers and rural communities in 33 counties of southern Wisconsin. Amber works with a team of lenders who specialize in serving the unique, financial needs of full-time farmers, part-time farmers, and rural homeowners. She grew up on a dairy and livestock farm in southwestern Wisconsin and has 18 years of agricultural lending experience. She received a Bachelor of Science degree in agricultural economics from U.W. Platteville and an MBA from U.W. Whitewater. For more information, check out www.badgerlandfinancial.com.