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Extension > Agricultural Business Management News > Managing Farm Finances in Challenging Times - Strengthen Your Cash Position

Monday, October 20, 2014

Managing Farm Finances in Challenging Times - Strengthen Your Cash Position

By Don Nitchie, U of M Extension Educator, Agricultural Business Management

Many business management experts agree having a strong liquidity position is very important in times of tight profit margins or to survive (hopefully short) periods of negative profit margins. What is financial liquidity? It is the ability of a business to meet current (typically within the next year) liabilities with current assets on hand. Not all current assets are the same though.

An old saying in the investment world is "cash is king". This implies the value of cash on hand in your bank account is a known amount, its price will not change tomorrow, and you can use it immediately to pay a bill, make a loan payment or as a down payment without any further action. Grain and livestock in inventory, if at market weight or market ready, are current assets and could be on your balance sheet at one price but worth something far different a few days or weeks later. So, during lean times it can be very advantageous to maintain an increased portion of your liquidity in cash - more than you have in the recent past. Dr. David Kohl, Professor Emeritus at Virginia Tech, advises to keep one year of debt payments or two months of cash expenses in cash on hand, not just at year-end but at all times.

Many of us who lived through the high interest rates of the 1970's and 80's have some aversion to having too much cash on hand, as our experience taught us to keep our money working and earning all the time. But, with rates of returns from crop farming substantially lower and bank savings rates extremely low, there is substantial value in maintaining a ready cash reserve. Having strong liquidity in uncertain times strengthens the financial sustainability of the business.

The Farm Financial Standards Council indicates the ratio of your current assets (cash in the bank, grain or livestock on hand and market ready & inventory of inputs) to your current liabilities (operating loans, accrued interest, accounts payable and annual fixed loan payments) should be no lower than 1.3. A farm business is considered very healthy if the ratio is maintained at 2.0 or greater.

The current ratio is a good measure of liquidity, but it can vary substantially through the year as sales occur, bills are paid, family living or draws occur, new loans are taken out and old loans paid off and especially as prices of unpriced grain and livestock inventory fluctuate. An analysis of 2,272 Minnesota Farms submitting their January 2014 data to FINBIN at the U of M Center for Farm Financial Management revealed that on average their liquidity as measured by their current ratio was very good, standing at 2.0. However, only 4.9% of their current assets consisted of cash and 69% was grain or livestock. If the majority of the grain or livestock was not priced, their financial strength was vulnerable to further market fluctuations. The cash held by these same farms would only cover 39% of their fixed annual debt payments and only about one month of cash expenses.

Tight profit margin years are in the foreseeable future, so it's wise to keep a higher portion of current assets in cash than has been done in recent years for the average farming operation. It is also very important, if holding more grain and livestock in inventory, to protect the price of that inventory to reduce the variability of your liquidity through the year. Even though interest earned for cash held in the bank is at record lows, that is a separate issue from holding cash for business liquidity purposes. When cash is maintained as one of your significant short-term business assets, at least the value is established and locked in for managing your liquidity. A strong liquidity position has value in strengthening the long-term viability of a farm business.


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