The Importance of Managing Profits, Working Capital, and Farm Improvements

A smiling lady shakes hands with a male farmer near a corn field.
16 Nov 2021

As we flip the calendar through November, it appears many producers are finishing up with harvest, or are at least able to see the end in sight. For some, this fall was a pleasant surprise given the drought conditions we experienced across the majority of our territory. For others, it may not have been quite as rewarding. Regardless of total crop size on your farm, there is opportunity to achieve profitable levels in 2021 given the higher crop insurance and commodity prices. With potentially higher profits than we have had for some time comes the responsibility as a business manager to protect, maintain, and utilize these profits to make financial progress on your farm.

The first and foremost concern each producer has as a business manager is to utilize various risk management tools to help your farm achieve profitability each year. While it is difficult to make general statements when our territory experiences varying weather patterns and different outside market forces, there were two risk management tools that took center stage in 2021 - crop insurance coverages and forward contracting of commodities. 

This year, crop insurance prices were some of the highest prices we have seen in recent years. If your farm’s yields struggled this year for one reason or another, crop insurance was an important tool in achieving profitable levels. With the looming drought and production uncertainty, producers were nervous to forward contract bushels through the summer months for fear of not producing enough bushels to cover their contracts. This is when the markets were near their highs. If there was a solid crop insurance plan in place, producers were much more apt to contract a portion of their multi-peril crop insurance (MPCI) guarantee and lock in some of those higher prices. Not only does forward contracting these commodities allow a producer to set a floor on those bushels, it also (under normal circumstances) allows you to remain profitable under periods of uncertain input cost fluctuations. Risk management and securing profitability potential are key components to any successful operation; however, it all starts by having a plan for adequate crop insurance coverages and market commodities at profitable levels.

When harvest is complete, and you sit down with your loan officer to put yearend numbers together, it is likely you will have a good estimate of earnings at that time. What you, as a manager of the business, choose to do with those earnings has a direct impact on the future flexibility, opportunities, and competitive advantages of your farming operation. After several years of compressed margins, I know the wish list for your operation may have grown quite long; however, I urge you to look at the overall picture of your farming operation and where profits might be best used. 

One such area is shoring up the working capital of your operation. Working capital is the “dry powder” of any business that allows you the flexibility to effectively and efficiently manage a farming operation. Sufficient working capital not only allows your business to take advantage of opportunities when they are presented while providing your operation with a competitive advantage over others. It also allows for a cushion during times of lower commodity prices. Over the past several years of lower profitability in the ag industry, working capital has been used to fund various purchases, losses, and family living needs when profitable levels were not achieved. If an operation goes into a period of lower profitability with a sufficient amount of working capital, they will most likely be able to use this as a buffer to weather the uncertain times. If working capital was tight to begin with, some tough conversations and hard decisions were likely made during this period of compressed margins. Now that there is optimism for higher prices back in today’s market, rebuilding working capital and protecting that “dry powder” may be one of the best uses of any expected profits, which would allow you the flexibility to take advantage of future opportunity. 

When working capital levels are within a comfortable range, it may be time to utilize some profits to make necessary equipment upgrades. Over the past several years of compressed margins, wish lists have inevitably grown to be quite long. While there may be a desire to upgrade most of the list given the potential for positive earnings and to help manage your income taxes, I would consider taking this wish list, writing all items down on a sheet of paper, and put them in order of importance to your operation. It might be helpful to rank the items that add efficiencies or reduce overall costs of production towards the top of the list and target those items first. Profitability in the ag industry is continuously driven by reducing costs of production on each unit of commodity you produce. When this list is complete, it is wise to sit down with your loan officer and analyze how the purchase fits into your operation regarding maintain adequate working capital levels, proper debt structure, and overall ability of the operation to service the additional debt. Crunch the numbers and make sure its fits into your operation’s future plans, your current goals, and overall financial condition.

As a loan officer at AgCountry, I work with many different types of farming operations that vary in size. While each one is unique, some of the most successful operations have two things in common - utilizing risk management tools to set themselves up for the highest chance of profitability and managing the financial aspects of the business through maintained adequate working capital and proper debt structure. By keeping a close eye on these two aspects, your farm or ranch will be better positioned to take advantage of future opportunities.

 
AgCountry employee Ben Johnson
Written By: Ben Johnson
AVP Loan Officer - Morris