Net Worth Statement with currency background

Editor’s note: The following was written by Bradley Zwilling, Brandy Biros and Dwight Raab, with Illinois FBFM and the University of Illinois Department of Agricultural and Consumer Economics, for the university’s Farmdoc Daily website Jan. 18.

If it isn’t already on your New Year’s resolution list, improving your financial reporting and your understanding of your balance sheet should be.

Navigating the challenging financial and economic environment makes it very necessary that you understand the factors affecting your balance sheet. That knowledge and understanding are the keys to surviving and thriving in the current low-price environment where margins are thin and cash is tight.

Today’s article discusses working capital, but keep in mind that working capital is merely the short-term or current part of your equity or net worth.

Understanding the causes of working capital changes will give insight on managing your farm business for 2019 and beyond.

Measuring the difference between your current assets and current liabilities at the same stage of the accounting cycle or production year is how working capital is calculated and evaluated. In the Midwest, we typically prepare Dec. 31 balance sheets. At that time, harvest is complete. Either the 2018 crop has been sold and is represented as cash on your balance sheet — assuming that cash remains unspent — or your 2018 crop is in end-of-the-year inventory and is priced (which creates a known dollar value that is a current asset) or unpriced, creating the need to set a price so that the value is reported as a current asset.

It is evident that commodity prices and the number of bushels represent two significant factors in current assets and changes from year to year.

Improvements or additions to your working capital are typically the result of profits from your farm business but also include any other sources of net revenue from non-farm businesses or off-farm employment.

Drawing upon working capital

If profit-driven improvements to your working capital are small, then improving working capital becomes a matter of controlling expenses so that current liabilities are not increasing.

And remember, not all draw-down of working capital is necessarily a sign of trouble. A planned build-up of working capital over a period of years followed by a planned draw-down of working capital could be the result of the planned acquisition of land or other assets.

What might appear to be a draw-down of working capital could also be a difference in reporting dates of asset values. Dec. 31 working capital can be vastly different from Jan. 31 working capital if intermediate or long-term debt payments are due in January. In that case, working capital (short-term net worth) is turned into intermediate or long-term net worth, and as such is turned into less liquid equity.

This is why it’s important to measure at the same stage of the accounting cycle or production year to make sure it is an “apples to apples” comparison of working capital from one year to the next.

Know your working capital

In this period of declining prices you must be in the practice of preparing an accurate balance sheet and accrual income statement. You need to have the knowledge that you can take action and price grain if you see opportunities to sell.

Don’t leave grain in the bin and assume that tomorrow or next month or next year will be better.

Now is a great time to reinvest your working capital into your next crop. Now is not the time for unplanned uses of working capital.

Paying federal and state income tax is OK, and is much better that spending working capital on depreciable capital asset purchases to solve a tax problem. There is no need to spend a dollar to save a dime.

It’s OK to leave your working capital as liquid cash. Having a supply of cash puts you in the position of being able to take advantage of opportunities that might materialize and lets you thrive in an economy that presents challenges — lower commodity prices, see-sawing trade signals, changing government regulation, etc.

If a refinance of intermediate-term or long-term assets is in your future, make sure you have considered the impacts carefully. Refinancing does provide cash to improve your working capital, but does not change your net worth. Refinancing merely takes some of your intermediate-term or long-term net worth and turns it into current net worth.

The obvious downside of refinancing term debt is that you are amortizing a short-term problem over a five-, seven- or even 15-year payback period.