The US agriculture sector’s level of working capital – an important indicator of its financial condition – has been in steady decline since 2012 and is now critically low warns Economic Research Service (ERS), part of the United States Department of Agriculture (USDA).
The ERS reports that the level of working capital available in the US farm sector now stands at US$38 billion against a peak of more than US$160 billion seven years ago and by far the lowest level seen since ERS started directly reporting the ratio in 2009.
The past five years “have resulted in a massive drain of [US] farm sector liquidity” according to the figures. Working capital levels this year are projected to be 25% lower than in 2018, which follows a 30% decline between 2017 and 2018.
The ERS data suggests that compared to 2014, the industry’s current level of working capital is just 31% of the value achieved five years ago and only 23% of the high achieved in 2012.
The sector’s working capital to revenue ratio tells a similar story to the working capital ratio, except that it peaked even earlier (in 2010 rather than 2012) at around 43%. This is because revenues increased even faster than working capital during a boom period for US farms. The working capital to gross revenue ratio is currently forecast to fall to 9% in 2019.
MFP to the rescue?
US website Agricultural Economic Insights (AEI) comments that the declines in North American farm sector working capital “are substantial and should be a cause for serious concern about the financial health of the sector”.
Some relief was provided in late May when the USDA announced the second Market Facilitation Program (MFP 2) to assist farmers hurt by trade disruptions and retaliatory tariffs imposed on their exports as a result of the US’s escalating trade wars. MFP 2 offers payments of up to US$16 billion and follows an earlier round of payments announced last September.
AEI says that MFP2 payments are likely to particularly benefit US producers of soybeans, who have been hit by the trade war, while recent increases in commodity prices may see some farms enjoy a better year than originally forecast by the ERS. However “it is paramount that they use this opportunity to rebuild working capital and liquidity.”
The AEI adds: “The last four to five years have created many financial problems in the [US] farm sector. The trade war has greatly exacerbated this situation. The MFP payments are of a magnitude that they can move the needle on financial conditions, but they will clearly not rebuild working capital to the levels that are necessary for long term financial stability.”
Advice for farmers
David Kohl, professor emeritus of agricultural finance at Virginia Tech University, says that working capital should be the top priority for balance sheets in the US agriculture sector. He encourages farmers to look at their working capital divided by total farm expenses. If that number is less than 10%, he says, it creates a vulnerable farm operation. Kohl classifies operations with 10% to 33% as resilient and farmers with greater than 33% as agile.
A few ways to restock financial reserves, he suggests, are to renegotiate cash rents, cut input costs, reduce family living expenses and diversify income streams.
The University of Illinois offers some further tips for farmers:
- Prepare accurate balance sheets to know your position:
In periods of declining prices, you must routinely compile an accurate balance sheet and accrual income statement. This will give you the knowledge to take action on pricing grain, selling assets, etc.
- A drop in working capital can still be good for the business:
A planned build-up of working capital over a period of year followed by a planned draw down of working capital could be the result of the planned acquisition of land or other assets.
- It’s the unplanned drops in working capital that spell trouble:
Now is not the time for a surprise spend of cash. Paying federal and state income tax is reasonable and is much better that spending working capital on depreciable capital asset purchases to solve a tax problem.
- Understand the pros and cons of refinancing assets:
Remember, refinancing does provide cash to improve your working capital but does not change your net worth. A refinance 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 amortising a short-term problem over a five-, seven- or even 15-year payback period.
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