Refinancing 101 – Understanding Agricultural Finance
Working capital (WC) is the biggest issue in farms failing. In challenging times, more than 90% of farms fail as a result of a lack working capital; meaning those farms are not able to stay in business long enough to realize a profit. Simply put, working capital equals current assets minus current liability. We want more current assets than current liabilities, so we’ll have a positive WC.
- Cash and cash equivalents
- Accounts receivable
- Raw material inventory and pre-paid
- Work in process/ growing crop and growing animals
- Finished goods or finished crops/animals
- Accounts payable
- Short-term notes (less than one year)
- Current portion of term debt
- Accrued interest
- Deferred tax liability
How much WC should an operation have? The generally quoted rule says $2 of current assets for every $1 in current liabilities, but that formula is not always relative to the size of the business. We prefer to use a percent of gross revenue as our yardstick, and we recommend at least 25% of gross revenue for row crops and up to 50% for livestock operations. Some banks want 30-35% of gross revenue for row crops and 100% for livestock operations. A lack of working capital has been a plague in agriculture for many years.
Recommended Refinancing Strategies
#1 Working Capital
Our first recommended strategy in refinancing involves working capital. If your working capital is not strong enough, you need to restructure your current debt to non-current debt to bring WC back to the recommended percentage of gross revenue; this is one factor in strategizing when to refinance. You should be proactive about this by anticipating your financing needs through budgets and constant monitoring of your financial position. Also, improve working capital by selling lazy or underutilized assets and pay down current liabilities.
#2 Review the Term Debt and Interest Payments of Your Operation
Term debt payments should not exceed 25% of the farm’s operating profit. If they are above 25%, the schedule for payback is too fast, or your total debt may be too high. In addition, net interest expense should not exceed 25% of your operating profit. If it does, this could be an indicator that you have too much debt for the operation.
#3 Review the Total Debt in Relationship to Your Operation Size
Here is a quick formula you can use as a rule of thumb: One year’s revenue + all current assets = maximum debt. Please note there is more to this than the formula; other factors must be considered. We'd be more than happy to explain it further, contact us for more information.
Want to Learn More?
Knowing your cost of production, having good financials and accurate budgets, and monitoring budget to actual are all critical to enhancing staying power through strong financial strategies. To discuss other factors involved in analyzing your total debt, and refinancing strategies in general for your operation, we encourage you to contact us today for your free consultation.