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Many Farms and Ranches Are in Survival Mode

Times were good for U.S. corn producers back in 2012, when prices stood at $7 a bushel. But since then, producers have watched as $7 fell to below $4, where prices have remained for nearly five years.

Like corn, other farm commodities are also feeling the pain of depressed prices. Soybeans, wheat, cotton, and other row crops also have been caught in the same sustained price slump. Many price levels are half of what they were five years ago and, in fact, now sit at or below the actual cost of production. Nearly all subsets of agriculture, including dairy and permanent crops like trees and vines, are also under pricing pressure.

As if weak commodity prices were not bad enough, an international trade dispute is inflicting new pain on American agriculture at a time when U.S. farmers, ranchers, and agribusinesses can least afford it. While trade/tariff relief has offered some support, most businesses in production agriculture are feeling adverse impacts from decisions made in Washington.

Working Capital Woes

It’s no surprise, then, that many agricultural operations, from farms to ranches to dairies, are losing money, and these losses are quickly eroding working capital. One chief credit officer at an agricultural bank said borrowers and bankers “got lazy” during the run-up in prices from 2007 to 2012. As prices began to plummet, lenders and borrowers often failed to notice, or address, the losses they were incurring and allowed these deficits to stack up on operating lines of credit. As a result, many producers are holding stagnant debt, carried over year to year, thereby choking off their working capital. Rising interest rates, of course, are compounding this financial problem.

Most of the recent large farm bankruptcies have revealed jaw-dropping collateral deficiencies that were either brought on or made worse by carry-over debt. Often, this issue is aggravated with input supply or other trade financing that may not be properly reported on borrower-prepared balance sheets. This vendor finance creates some unique challenges in agriculture, as state laws vary on supplier liens. In some instances, a supplier is allowed to trump a bank lien without even notifying the Uniform Commercial Code (UCC) lien holder.

The ‘Typical’ Ag Workout

Farm real estate makes up the vast majority of equity on most farm balance sheets. This equity offers options for addressing working capital concerns by “terming out” losses, capital expenditures, living expenses, and other cash outlays that don’t belong on an operating line.

Thanks to a renewed interest in farmland, a plethora of farm real-estate lenders offer a variety of debt structures, including traditional mortgages and nonrecourse and hard-money style loans. Between long-term amortizations, negative amortizations, and interest-only notes, many of these structures minimize required debt service, which is critical for making the cash flow work given the depressed margins in agriculture.

The key to this refinancing in almost every farming operation is the overall leverage level. If the loan required to refinance existing term debt and right-size working capital creates a debt-to-asset ratio of 60 percent or less, there are options. If the debt-to-asset ratio is 60 to 65 percent, it will be difficult but not impossible to refinance. Farms with a debt-to-asset ratio above 65 percent need not apply. These highly leveraged farms will need a capital injection to move forward.

A Closer Look at Expenses

Against this backdrop, farmers, ranchers, and other agribusinesses are strongly advised to adopt or revisit best-practice solutions, especially those for cutting costs. Most of production agriculture operates on a low-cost provider business model, where every cost must be heavily scrutinized. While most farmers pride themselves on their ability to operate in a low-cost environment, the data tell a different story. Few producers truly have the scale, buying power, processes, and data, and can execute well enough to be low-cost. Even fewer can continually command a premium that allows for less expense scrutiny.


 

Most of the recent large farm bankruptcies have revealed jaw-dropping collateral deficiencies that were either brought on or made worse by carry-over debt.

 


Production agriculture is similar to a manufacturing job shop. Very few producers are able to move beyond the commodity nature of a job shop and into true value-added manufacturing. Despite that, there are always additional areas for cost-cutting or raising working capital, including:

  • Household Spending. Household spending tends to be higher than it should be during this downturn. For example, a farmer with 20,000 acres in the Dakotas believed he and his family were living on $80,000 a year. In fact, a closer look revealed his annual household spending was $200,000. Such a miscalculation is easy to do. There is a lot of blending between household and farm needs, which can blur actual household spending.

  • The “Big Four.” Focusing on seed, chemicals, fertilizer, and labor may produce major cost savings. These are the four expenses that move the needle for most farms. There are several great methods for benchmarking these expenses that every farmer should be using. In many instances this will involve blowing up long-term buying relationships to explore new, and more economical, inputs.

  • Idle Assets. Liquidating excess assets is another step that can help boost working capital. Almost every farm or ranch has extra equipment, vehicles, and machinery lying around. One farm in the Carolinas had two peanut combines on its property—even though peanuts had not been grown there in five years. Producers must identitfy assets they can do without. Selling those items can generate tens, even hundreds of thousands, of dollars. That is essential when they need cash now.

  • Sale-Leaseback Arrangements. Taking advantage of a sale-leaseback arrangement offers another option for cash-strapped farms to raise working capital. Tractors, combines, sprayers, and other farm equipment are expensive. Many farmers have built up substantial equity in their machinery, often measured in millions of dollars.

One way to unlock that equity is to sell the equipment and then lease it back for an extended period. This not only brings in cash to the operation but also allows the farmer to continue using the equipment. Another option is a sale-leaseback on their farmland, but this can be a bitter medicine. There are many buyers for farmland, but few purchasers want to sell it back to the farmer under a first right of refusal option. That leaves a farmer as a tenant on land he once owned. Since selling land is foreign to most farmers, few will even consider this option. If it is the only option that stands between a farmer and bankruptcy, however, such an arrangement is viable.

Another best practice agricultural producers are encouraged to explore is determining whether they are the low-cost producer in their area, niche, or crop. How do they compare to their peers? Have they benchmarked their numbers to see for sure? That information is readily available through the local university extension office, an accountant or lender, and several farm/ranch enterprise resource planning (ERP) systems.

Agricultural data are notoriously behind the times, especially given the size and risk of many farms, so progressive growers are upgrading their processes, systems, and reporting capabilities to unlock quality information. There is simply no way to compete successfully in the current agricultural environment without knowing the numbers.

Conclusion

Farmers and ranchers cannot do much about the downturn in farm commodity prices. But they can and must safeguard their businesses by ensuring they are operating with the right amount of working capital. They must reduce debt, optimize their debt structure, and minimize cash outlays. Sadly, too many agricultural producers do not seek help until things are too far gone, when it is too late to solve problems and there are too few options left.

Agricultural experts do not see a big price rally on the horizon. That means farmers who are bordering on financial problems must start having conversations with a qualified advisor as soon as possible. Assessing the fiscal health of a business and setting it on the path of financial healing takes time and effort. It may even be painful. But saving the farm, especially one that has been in the family for generations, is worth it.

Peter Martin

Peter Martin

K-Coe Isom

K-Coe Isom is a national leader in food and agriculture consulting and CPA services. As one of the firm’s principals, Peter Martin serves as a success catalyst and valued advisor to business owners and leadership teams. A finance and growth consultant and former lender, Martin helps businesses identify opportunities, source capital, and manage expansion challenges. Contact him at martin@farmjournal.com. Follow him on Twitter @martinptm.

Topics: 
Agriculture
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