Many farmers are in loan renewal season with their lending institutions, and the term working capital will be a part of conversations.
So, what exactly is working capital? The equation is simply balance sheet current assets minus balance sheet current liabilities, says Lori Tonak with the South Dakota Center for Farm and Ranch Management.
Current assets are ones that will be sold or turned into cash in the next 12 months, Tonak says in a news release. For an ag producer, these would consist of grain, market livestock, feed, growing crop, prepaid inputs and accounts receivable.
Current liabilities would include accounts payable, operating line balances, accrued interest, input financing from a vendor, as well as principal and interest payments due on your intermediate and long-term loans within the next 12 months.
Why is working capital so important? The stronger the working capital is, the less reliant you are on your lender and the better prepared you are to withstand tougher times. If your budget this year shows you are going to lose money, that loss will be absorbed by your working capital.
If you lose $50,000, it will reduce your working capital from $250,000 to $200,000. No one wants to go backwards, but that is one of the reasons to maintain strong working capital, to be prepared for just such an occasion.
Over the past few years, working capital has been decreasing as commodity prices remain low. Another hit to working capital has come from reduced crop yields due to extreme moisture and livestock loss from extreme weather events during calving. Farms with large amounts of equipment and land payments can struggle.