We recently enjoyed a meeting with Sir Loin, a gentlemen beef farmer who immigrated from England in the fall of 2002. We know what you’re thinking. English, gentlemen, and beef farmer: is that possible? Okay, we admit, sometimes we embellish the truth for the purpose of a good column.
Sir Loin’s position was this. He has toiled through poor margins since the onset of BSE. His banker, Hans Immapocket, has treated Sir Loin like a leper in recent years, hardly passing a glance his way, even during the Christmas bonspiel. The local Dodge Truck dealer quit phoning four years ago.
But Sir Loin is smiling now. The yard is full of hay, his pens full of fairly priced calves, and his cow herd is in great shape because he aggressively culled in recent years to generate cash flow. Getting to this point hasn’t been easy. Sir Loin has built up significant accounts payable with local suppliers and his operating line of credit remains close to his limit, as it has for many months now. Sir Loin loves the cattle business and called us out to discuss his plans for expansion. Sir Loin had 200 heifers in the pen, pasture for 150 and wanted to retain 150 this summer for breeding and retention in the herd. After much discussion and analysis, our report and advice centered around the following:
First, the business has to be in a position of financial strength to support growth. Upon analysis of his liquidity it was apparent that some of Sir Loin’s accounts payable were high interest bearing accounts. We identified the following options to restore this working capital.
One option is to term out his accounts payable and operating line of credit with his creditor. This decreases the interest rate and lowers the impact on cash flow as payments are made over time. The reality is that his historical income tax does not demonstrate the very recent positive margins in the beef industry. The bank is in the risk business, not the farm speculation business and, as such, terming accounts payable out with the support of weak income tax is viewed as risky lending and may not be an option.
It was determined that the sale of 100 heifers would clean up his accounts payable in full. The remaining cash flow projection indicated that the operating loan would not revolve completely and that was the focus of the last discussion he had with Hand Immapocket. For that reason, in addition to the sale of the heifers, Sir Loin would request that the bank term out 50 per cent of the value of the 100 remaining heifers. This restores Sir Loin’s liquidity and allows the operating line to remain within its limit and revolve accordingly.
The following targets were used in this financial planning;
Current Ratio: Current Assets/Current Liabilities. The target: 2.0.
Working Capital Ratio: (Current Assets — Current Liabilities)/Cash Operating Expenses. The target: 65 per cent. A working capital ratio of 65 per cent indicates that roughly 35 per cent of the fiscal year’s operating expenses are financed.
Fixed Charge requirements per cow = (Payments+Land Rent+ Leases+Taxes+ Living Expenses)/Number of Calving Cows. The target: $300. This target was calculated based on historical expense levels, historical production levels, and a conservative estimate for future market levels, all three of which will be unique to each operation.
The moral of this story is that very few businesses can expand their way out of a problem. In order for expansion to make sense over cleaning up high interest bearing accounts payable, the return on the capital tied up for the expansion must be greater than the carrying cost of the payable. This also carries with it the false assumption that the guy carrying your payable has agreed to be the financer for your expansion. The beef industry has endured tremendous hardship since BSE, floodwaters, and drought. The beneficial change in the markets has illuminated tremendous light at the end of this long tunnel but one has to be careful not to crash into the wall on the way out. †