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Repositioning after a bad year

Franklin Fungusfut called last week, concerned about the situation on his 3,000 acre grain farm. He had a rough year, with poor seeding conditions crops got in late and got off to a slow start. He only seeded 1,500 acres and most of these crops were not great.

Frank called, concerned about his position headed into the 2012 crop year. He wasn’t exactly sure of the impact that 2011 had, but he knew his inventories were down and his operating loan was way up. He likes to be proactive and was looking for options to conserve his working capital and ensure that he has enough cash to put in the 2012 crop.

The immediate impact of a poor crop on a business is that the working capital erodes with significant negative implication on cash flow. Working capital (current assets minus current liabilities) should represent the cash available to fund next year’s operating activities. Current assets are largely made up of crop inventory which, if lost in a poor crop, are gone overnight. This often shows up as problem the next year when the operating loan is still outstanding from the previous year and you have to get the next crop in.

Frank’s problem is far more easily dealt with proactively than reactively. In the spring, the same options may not be available that are available now. Frank’s goal is to ensure that he has access to adequate cash to operate in 2012. He is looking for options to conserve cash now so that it will be available later. We brainstormed with Frank and arrived at the following potential strategies.

  •  Agristability interim payment
  •  Increased use of cash advances
  •  Postpone principle payments on term debt
  •  Delay capital purchases
  •  Term out recent capital purchases
  •  Sell non-essential assets
  •  Term out existing accounts payable
  •  Negotiate additional trade credit or terms on existing trade credit
  •  Downsize for 2012
  •  Seek additional investors

Options to raise cash

Two of the most affordable sources of cash include an Agristability interim payment and the Advance Payment program. Frank is concerned about the Agristability program reliability — he is comfortable taking out the advance, however he wants things lined up so that he’ll have available in the future in case he turns out to be in an overpayment position.

Postponing principle payments on term debts is more easily negotiated proactively. Once the payment is made it is difficult or impossible for a lender to refund this payment. Making interest only payments means that cash that would have gone to principle is now available for the business to use in 2012. The request is more easily completed for the lender now, as the analysis of the operation is based on historical income statements which would not include the current crop year. At this point, Frank’s industry is not in turmoil and the credit department for Frank’s lender currently looks favourably on the grain sector. If Frank’s request comes after a high number of other requests the comfort level with the industry quickly disappears.

Frank had been considering a combine and tandem upgrade and his wife was considering a time share. All of these can wait until he knows what this crop year looks like. Some of the cash that would have gone into these purchases will go into repairs, however less cash will be used and no new debt will be incurred.

Last fall Frank purchased a scraper and a grain cart with his operating line of credit. Although his line of credit is adequate for the 2012 season it appears now that a more appropriate way to fund these purchases would be through a five-year loan. Going to the bank now and making this change will replenish Frank’s working capital and give him access to more cash in the spring of 2012.

Frank has rigid straight cut header for his combine which he decided to keep as a back up when he purchased a draper header two years ago. He likes the draper header and does not anticipate using the rigid header. He feels he can sell this header for reasonable money without impacting productive capacity of the farm.

Obtaining a term loan secured by mortgage to pay out accounts payable is an option that would restore working capital to a business. Frank does not have sizeable accounts payable and as such will not be using this option.

Negotiating terms on trade credit is an option that Frank might pursue. He has pre-purchased his 2012 fertilizer requirements and anticipates pre-buying herbicide before the end of March. He can request an increase in his trade credit limit and request extended terms on this pre-buy to allow him to repay it at a later point.

Frank has some rented land and the lease is up for renewal this winter. Dropping this rented land would lower his input costs for 2012. He does not like this option and will only consider it once he’s exhausted other options. This is a big decision that should not be taken lightly. Although it lowers input costs, it also lowers the number of productive units (acres) over which fixed costs are spread.

The final option is to seek outside investors. Frank’s single aunt has recently indicated that she is sick of the volatility of the stock market. Frank could offer to sell aunt $300,000 of redeemable preferred shares in his company. This would replenish working capital and give his aunt a more stable return.

The decision

Frank decided to sell his header, delay buying his new combine and tandem and try to postpone his principle payments. These were options that Frank had no problem doing.

We put them into his projection and cash flow to see the impact on his working capital. After looking at his cash flow Frank also decided to term out the scraper and grain cart — this put his working capital back into an adequate position. Frank feels comfortable going into spring and is confident he can manage through whatever Mother Nature throws at him this year.

Frank recognizes requesting additional financing and principle postponement may be a difficult request and understands that his overall plan will need to be communicated very clearly. †

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