Every company that wants to pass on its business to the next generation needs a business succession plan.

Sooner or later, everyone wants to retire. However, determining what happens to the business can be as important as ensuring that you have enough money to retire on. Who’s going to manage the business? How will ownership be transferred?

With family businesses, succession planning can be especially complicated because of the relationships and emotions involved and because many people are not comfortable discussing topics such as aging, death, and financial affairs.

As we have written in the past few years from time to time, all the things mentioned, and many more, contribute to the resulting financial position of every farm operation at year end. One of those key measurements of one’s financial position is working capital. 

By now, I acknowledge that you might be thinking: “Yes, Lee, this is like the fifth time you have written about working capital and I know it is important to keep my working capital strong. By the way, that’s easier said than done.” If you are thinking that you would be right. However, rather than preach about how important working capital is or comparing it to other analogies (remember from past articles that it is sort of like measuring how much fuel you have in the tank to keep going), let’s take the concept a step further and dive deeper into just how various levels of working capital provide benefit beyond the generalities of “absorbing financial shocks” or “allowing one to jump at opportunities.” Here are some examples.

I was not a math major in school, but obviously the more working capital a person has, the more frequent and/or larger opportunities can be pursued. While in general, an operating line of credit is meant for just what its name implies—operating expenses, depending on one’s situation, there are times it might make sense to use working capital (which could mean borrowing from one’s operating line of credit short-term until more grain or livestock is sold) to finance all or part of a purchase. Maybe some capital purchase or improvement is needed and failure to act fast results in “the price going up by 20% next Monday.” In certain cases, a portion of working capital may even make sense to use as a down payment on a capital asset because of financing requirements or just to keep the payment within a certain amount. The list can go on. Mind you, having working capital present in the operation doesn’t necessarily mean one should invent opportunities just for the sake of using the working capital, however. I say this because……

he best way to describe this is to use an example. For several years, the bank has compiled its own averages based on approximately 130 farm operations the bank finances. Over the past several years, especially since 2012, we have seen on average that working capital levels have trended down, again on average. This is directly correlated, of course, to the general downtrend in prices while costs stayed relatively static during those years. For some operations, that decline in working capital has left them relatively unscathed, speaking from the standpoint of having to change line of credit limits or not having to refinance carryover debt from one year to the next. In some cases, refinancing either due to carryover debt or to simply term out capital purchases from the past year or two became necessary sooner than anticipated. Either way, and just like various vehicles on a parking lot having various levels of fuel in the tank, action must be taken at a certain time for some, and either sooner or later for others to keep the vehicle running. Sometimes it could happen that strong working capital, part of which is used in a certain year to jump at an opportunity results a few years down the road of a faster or sooner occurring “burn rate” that Dr. Kohl talks about. However, depleting that reserve is a potential tradeoff too.

Some might ask, “I have this working capital sitting here, what good is it actually doing in terms of return to the operation versus investing it elsewhere in the operation?” There are two answers to that question. The first has to do with basically what has been discussed so far, which is having the liquidity to be proactive, or if necessary, be reactive (preferably in that order). In other words, you can’t always put a dollar value on having flexibility. The second answer would be that a person could make the case that having working capital “sitting there” whether it is anything from $1.00 to $1,000,000, in general it means $X less of operating credit borrowed. Therefore, borrowing whatever amount less from year to year means that working capital is essentially creating a return equal to the interest rate on the line of credit because that amount of money is not borrowed. Compare that to, just as one example, purchasing land at current market and cash rent rates, looking at it as an investment. Current rates of return on land might be in a range of 2% to 3.5% in this area recently assuming that same dollar amount or portion thereof of your working capital would be invested in something like that. We’re not implying that investing working capital into land or other assets is a good or bad idea. The main point here is to illustrate that perhaps working capital is not just “sitting there”, but rather is in fact providing some benefit to the operation beyond preparing for that “rainy day.”

As you look at your operation this winter and evaluate your working capital position, ask questions such as what can be done to increase that level, how to evaluate various opportunities and the impact that might have, and the list goes on. When you have discussion about this, what might be the best takeaways you hope to discover? Talk to your lender about this, because you’re not alone in evaluating your situation!