Keeping enough cash on hand to pay bills is an elementary rule of money management, but that doesn’t mean it’s always followed. Similarly, having enough working capital to support your pork production business makes sense, but it’s too often a rule that is broken.
Working capital is defined as current assets minus current liabilities, or the assets on hand that you plan to sell within a year minus liabilities you currently owe, that you will pay in the next year. For example, buildings and breeding animals would not be considered current assets.
“It’s imperative to have enough working capital to weather down times,” says Mark Greenwood, vice president of a commercial lending-swine group for AgStar. “Low hog prices can cause producers to market pigs at light weights, and make other decisions based on cash-flow needs versus the best long-term business choices.”
There are other reasons to maintain sufficient working capital, or liquidity says Allan Lash, president of Agri-Solutions. They include:
During good times there are more expansion/growth opportunities.
During bad times for others, there are more expansion/ growth opportunities.
Liquidity often reduces costs (lower interest rates).
Liquidity reduces stress.
During difficult times such as low commodity prices, downturns in the economy or lender problems, there is sufficient cash for the business to continue.
There are five factors that you need to review to determine whether you have sufficient working capital, says Lash:
1. Do you have the ability to hold the end-product through times of low prices? Pork producers, unlike grain farmers, are not able to do this. So pork producers are sometimes forced to sell product at a loss.
2. Is any one expense a dominant expense? For pork producers, feed costs are dominant costs.
Is this expense volatile? Feed costs fluctuate, which is another reason why pork producers need a solid working capital supply.
3. Is there a government price support or underlying guarantee? There is no government support program for pork producers. However, many producers have packer contracts that include a price floor, so that should be taken into consideration.
4. Does disease kill or just slow production? With crops, diseases typically don’t wipe out the entire crop. But in pork production some diseases, such as porcine reproductive and respiratory syndrome, can slow production or wipe out a herd.
5Is there replacement cost volatility? This depends on your operation, says Lash. If you raise your own replacement gilts, volatility likely is low.
However, if you buy feeder pigs and finish them out, the price of feeder pigs can be quite volatile.
“Producers buying feeder pigs absolutely need the most working capital of any pork producers,” says Lash.
He notes that contract producers can get by with the least amount of working capital. He says farrow-to-finish and farrow-to-wean producers fall somewhere in-between.
Greenwood agrees saying that he requires farrow-to-finish producers to have at least $300 per sow of working capital. For wean-to-finish producers that also have crops, he looks for a ratio of at least 1.4:1 of current assets to current liabilities. Lash and Greenwood believe that ratio should be closer to 2:1 to play it safe for livestock-exclusive producers.
More working capital is needed in today’s pork industry than was required in the past, because there is more volatility.
“We’ve raised the bar for working capital,” says Greenwood. “Over the last several years market-hog prices have fluctuated between $8 and $65 per hundredweight. Variations will probably continue in the future, so the industry needs to be more prepared to face adversity than in the past.”
Few pork producers have sufficient working capital, he contends.
The question then becomes how do you avoid problems?
“The best way to deal with working capital issues is by making a profit,” says Lash. “There are other options but they are poor substitutes. Making a profit is the only way to get and maintain working capital over time.”
That can involve the input side of your production equation as well as the output side. Efficiency, purchasing strategies and selling plans all figure into your business’ profit potential.
Among the other options, the most common is to restructure your loans. Greenwood says you can take some equity from your assets – like your hog buildings – and use it to spread some of your current debt over the long term.
You also can build working capital by selling long-term fixed assets, such as breeding animals or facilities. But that can hurt production, so it’s not typically recommended, says Lash.
Bringing additional equity into the business in the form of a partner is another option. Bear in mind, however, that means giving up some independence and decision-making freedom.
The last option is bankruptcy. Since bankruptcy is never a good option, it’s important to monitor liquidity before it is too late. Some things that you should already be doing, like keeping good records, can help you in determining your liquidity.
“The bottom line is you need to know your production costs, and try to get better every day,” says Greenwood. “You also need to have a good relationship with your packer, and be able to take advantage of market opportunities to enhance your revenue.”
When Lenders Go Away
Allan Lash, president of Agri-Solutions, notes that lenders sometimes change their agricultural lending policy. Sometimes lenders choose to reduce or eliminate their funding for agriculture. Sometimes even if you are current with payments, they may still ask you to pay off your loans. When and if that occurs, liquidity becomes vital.
He uses two situations to illustrate the value of having working capital on hand, in case your lender decides not to continue loaning money to your business.
Scenario #1: Let’s say you have a 2:1 current assets-to-
liabilities ratio. This means if you have $200,000 incurrent assets and $100,000 in current liabilities, you can sell $100,000 of your current assets and pay off your liabilities. You would still have $100,000 on which to operate your business.
Scenario #2: You have a 1:2 current assets-to-liabilities ratio. That would mean if you owed $100,000 in current liabilities, you would only have $50,000 in current assets. Even after selling all of your current assets you would still owe $50,000.
In the second scenario, you might try to restructure $100,000 of debt by refinancing fixed assets. However, that can be dangerous.
Say you restructure your debt so that $30,000 is due this year, and the remaining $70,000 will be paid by making payments of $10,000 over the next seven years.
“The problem,” says Lash, “is if you don’t make enough additional money to make the payments, you’re just adding another $10,000 to the current liabilities every year.”
Be wary of quick and short-term fixes.