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September 22, 2023
Football season is upon us, and the official start of fall is just around the corner. In pigskin format, let's examine some of the quick-hitter questions that have come from conferences and seminars over the summer.
Many proactive operators know that working capital is a shock absorber when cash flows and profitability are limited or negative. How does one determine the amount of working capital needed?
My favorite metric for working capital (current assets minus current liabilities) is working capital divided into total operating expenses, including depreciation. Lenders will often use the current ratio, which is current assets divided by current liabilities. Personally, I think producers can relate better to the percentage of expenses. For example, if annual expenses are $1 million and working capital is $250,000, then the ratio would be 25%. This means that three months of expenses could be covered by working capital generated internally. This metric would normally be sufficient, but one must ask critical thinking questions.
First, what is the quality of the current assets such as inventories and receivables? What is the quickness to cash, or how long will it take to convert current assets to cash? A prepaid or marketing contract on crops or livestock may require time before converting to cash. What are the current liability obligations and the timeline of payment for accounts payable, lines of credit and accrued expenses? Will there be capital expenditure needs, lease payments due or debt service payments required during the period? Working capital analysis and a quarterly cash flow can be powerful tools in developing strategies such as options, hedging and crop insurance to mitigate volatility and risks to cash flow that often occur during the year.
One must conduct a management needs assessment along with determining a timeline of transition. In family businesses, someone from the senior generation often has more expertise in areas such as finance, marketing, procurement and human resources. Are they ready to transition responsibilities and accountabilities, and what is the timeline? Are they ready to mentor the new generation and allow new techniques and methods within the core values and goals of the business?
My advice to the younger generation is not to wait too long to begin the management transition process because it is easy to get caught in the day-to-day trap of operations and dealing with the issues of the day. Open communication is the expectation which often requires an outside advisor or facilitator to establish processes, procedures and accountability. Above all, get everything in writing to ensure everyone stays on the same page throughout the entire process.
Dr. Kohl is Professor Emeritus of Agricultural Finance and Small Business Management and Entrepreneurship in the Department of Agricultural and Applied Economics at Virginia Polytechnic Institute and State University. Dr. Kohl has traveled over 10 million miles throughout his professional career and has conducted more than 7,000 workshops and seminars for agricultural groups such as bankers, Farm Credit, FSA and regulators, as well as producer and agribusiness groups. He has published five books and over 2,500 articles on financial and business-related topics in journals, extension and other popular publications.