Auction sale season is upon us, making both the wife and the banker a bit nervous. Hopefully the biggest challenge you face this year is from overindulging on the coffee and cherry pie, unlike a gentleman we worked with a year ago, Harley Handup. He is a regular at auction sales and he just can’t keep his hands in his pockets.
Harley approached us late last summer in a bit of a bind. His operating loan was at its max, his cash advance was spent, he was a month away from having any crop to sell and he needed cash to finish up harvest.
Harley was a good producer who prided himself in producing top yields, knowing his costs, and managing his expenses carefully. But in 2008, Harley was faced with skyrocketing fertilizer and fuel prices that had stressed the operating loan’s ability to cover all the payments and expenses. By the time we arrived on the scene, the cash flow problem had already forced Harley to skip a fungicide application on some of his later cereals — a decision that proved very costly. Harley had contacted Hans Inmapocket, his local bank manager, to request an increase in his operating line, which was secured by a typical general security agreement (GSA). With already $200 per acre in operating credit and no grain inventory on hand to speak of, Hans was hesitant to simply extend more operating credit and suggested that Harley explore other options. We had prepared a budget and projected cash flow the previous December for Harley and compared his actual crop input costs to those figures used in the projection. We quickly realized that the increase in the fuel and fertilizer costs did not completely explain the higher operating loan position. Ruling out the crop input costs, we began to further examine the actual business activities within the business to determine additional causes for the higher than anticipated operating loan balance. We examined:
1. Higher than expected living expenses or salaries
2. Accelerated debt repayment
3. Lower prices received for commodities sold than in the projection
4. Unexpected increase in accounts receivable
5. Early demand of accounts payable
6. Capital purchases
We found no apparent causes for the dilemma until we inquired about any unexpected capital purchases. Harley’s hand shot into the air and he began to stutter like his favourite auctioneer. Harley had attended his neighbour’s auction sale in April and while choking down his third piece of pie, it became obvious that the crowd had gone to sleep and the combine was going cheap. Harley’s instinct kicked in and the bidding began. Initially, Harley was thinking, “I have the exact same machine at home so I won’t need another line of parts. I know where the combine is coming from and I can hardly see the auctioneer because that combine is shining so brightly. Surely it doesn’t need any work.”
Just as the bid was reaching beyond what Harley considered cheap, he realized he was bidding against his long time neighbour and arch rival, Boss Hogg. Boss had a large farrow to isowean operation and only had a few acres. Harley wondered how he could afford it and even if he could afford it, Harley wasn’t about to let him have it. Next thing Harley remembers, he was dropping his pie on the ground while he was fumbling into his coverall pockets to retrieve his bidding number.
We knew that Harley’s weak point was auction sales. He was no stranger to iron and often to avoid raising concern at home and at the bank, he would simply put the purchases on his operating line. In other years, Harley had been able to cover all of his operating expenses in spite of carrying auction sale purchases in his operating line, but not in 2008. Increased input costs had him in a bind. In the eleventh hour before harvest, it became clear that Harley should have taken out a new term loan for the combine purchase. Then only the down payment for the combine purchase would have impacted the cash flow.
In a joint meeting with bank manager Hans Inmapocket it became clear that term financing was available to Harley’s farm for such a purchase. Inmapocket was in fact comforted to know that the rising operating line was not the result of net farm losses from high input costs, but rather from capital purchases that were not properly funded. Care needs to be taken for if at some point Harley’s farm is not able to support additional term financing, that last minute decision at the auction sale could carry with it dire consequences.
Capital purchases need to be planned and communicated with the rest of the financial management team. If operating credit is going to be used to purchase capital assets, the management team needs to be certain that cash flow will not be jeopardized as a result. If there is any question, the capital purchase needs to be funded with term financing. If term financing is not available, there are larger problems in the financial structure and performance of the business, which will only be compounded by further financing, short or long term. So in keeping with your commitment to plan capital purchases, keep your eye on the pie, add an extra cube of sugar in your coffee, and keep your hands in your pocket unless you have planned otherwise.
Andrew DeRuyck and Mark Sloane manage two farming operations in Southern Manitoba and are partners in Right Choice Management Consulting. With over 25 years of cumulative experience, they offer support in farm management, financial management, strategic planning, and mediation services. They can be reached at [email protected]and [email protected]or (204) 825-7392 or (204) 825-8443.