Second, current assets typically include the inventory of purchased inputs such as feed, fertilizer, seed, chemicals, and fuel that will be needed for future production. If these inventories are converted into cash to cover unexpected losses or other cash needs, they must be replaced relatively quickly to continue to feed the livestock or produce the crop, so they are not readily available as a buffer for financial losses.
Third, the vast majority of farmers file their taxes on a Schedule F tax return, and the tax rules define the tax basis for raised grain and livestock as zero 0 for Schedule F filers. Consequently, any inventory of raised grain or livestock must be reported as taxable ordinary income at its full gross revenue value.
Only if cash expenses are incurred for production in the upcoming season will a tax deduction be allowed. Given expected cash flow and financial pressures, farmers may not have the cash to prepay expenses at the same level as they have in the past, so income tax burdens are expected to be higher in The sale of inventory from previous years is likely to trigger a deferred tax obligation, thus reducing the cash available upon that sale and thus the financial buffer from those liquid inventory assets.
So one of the easiest ways to manage working capital is to protect cash. When the business generates cash from the sale of products, it can be held in that form, committed to the purchase of inputs for the upcoming production season, or it can be used to purchase capital items or withdrawn from the business. Purchasing assets or withdrawing cash from the business may be necessary in specific instances. The discussion above suggests that maintaining a strong cash position is an important way to manage working capital.
In addition to the drain on cash and thus working capital from asset purchases or withdrawals, the repayment schedule on debt also has a significant impact on working capital. Shorter repayment schedules on debt used to purchase capital assets such as land and machinery results in larger annual principal payments and reduced working capital.
Extending the repayment terms through refinancing can reduce principal payments and thus the pressures on cash flows, leaving more working capital to be available to buffer financial stress.
If adequate collateral is available, the debt might be restructured with some of the operating line added to the term debt so that it can be repaid over more years, thus reducing current debt obligations and increasing working capital. This strategy is often not the first strategy pursued, but it situations in which cash is relatively short it cannot be excluded from the tool box.
When selling capital assets, it is important to consider capital gains and losses, and depreciation recapture, which may trigger a tax obligation resulting from the sale of assets. Table 1 presents a balance sheet for a case farm in west central Indiana. The computation of various liquidity ratios for the case farm are illustrated in table 2.
The working capital to gross revenue and working capital to total expense ratios were percent and percent, respectively, indicating that the farm has a strong liquidity position. Working capital can also be expressed as a proportion of crop acres. The current ratio was approximately 5. Table 1. Balance Sheet for White County Farms, Our recommendation tool can help you find the right financing. You are using an unsupported browser version.
Learn more or update your browser. What is Working Capital? What is working capital — and why is it important? Facebook LinkedIn Twitter. You may also like Tips for managing your cash flow Establishing and maintaining good business credit 3 Reasons why liquidity is important for your business « Back to small business lending resources. Get the funding your business needs Our recommendation tool can help you find the right financing.
Get a recommendation. Connect with us. If you do have a financial model, plug in your best and worst case scenarios in terms of growth, expected customer payment periods, and inventory levels. You will be handicapped if you are only able to use historical information. Analyze the use of working capital for non-operating purposes over the next 12 months I assume the future analysis will cover a one-year period.
For any investment or asset purchases funded from working capital i. The calculation should be:. Operating profits or losses will have an impact on working capital as well. For the coming 12 months add projected profits or subtract projected losses to calculate projected working capital available for the next 12 months. Now reverse the WCA formula to solve for working capital required the amount of working capital required during the next 12 months.
Look at your average accounts receivable collection period and determine how much cash you will generate from sales revenue over the projection period.
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