Agricultural lenders listed liquidity and working capital as their top concern for producers this crop year, according to a survey conducted by the American Bankers Association and Farmer Mac last August. This is likely an indicator that lenders are seeing the outlook for lower commodity prices while at the same time retaining elevated input costs, including interest rates on operating notes. Because of the nature of agriculture, where there are months when cash outflows exceed inflows during the growing season, liquidity and working capital should be a priority every year, regardless of market outlook.
Liquidity is a producer’s ability to meet their cash financial obligations as they become due. Working capital is a measure of liquidity that measures how much current assets exceed current liabilities.
Current assets and current liabilities are found on the balance sheet. Current assets include cash and other assets that can be converted to cash relatively quickly, while current liabilities include any debts that are due within a year or less. Some examples of current assets include cash, inventories of crops, market livestock, livestock products and supplies, accounts receivables, prepaid expenses, marketable stocks and bonds, and the cash value of life insurance. All of these can be quickly converted to cash to pay any debts that come due. Current liabilities are debts or obligations that must be paid within a year’s time or less, including accounts payable to merchants and suppliers, current notes payable and the current payments required on long-term notes payable to lending institutions.
Liquidity, by definition, is related to cash flow. In agriculture, a pro forma cash flow statement is a great tool to estimate cash flows and working capital balances for the upcoming crop year, providing an idea of the approximate timing and size of inflows and outflows. Of course, it is difficult to truly predict the future. As a result, producers need to have an appropriate amount of working capital on hand to provide flexibility in meeting uncertain cash flows.
An example of this occurred during the planting season this year. The weather was unusually wet in some areas this past month, leading to saturated soils that caused seedling damage. Some producers had to make the decision to replant some of their fields. Those who had the working capital available were able to afford this unexpected cash outflow. Liquid reserves, by means of working capital, are necessary for the sustainable operation of the farm business every year.
With an entire month of the new year behind us, meeting season is in full swing. This season is a time when many agricultural economists get the opportunity to provide market outlooks for the upcoming year for the commodities producers grow and the inputs used to grow them. Last week, a producer approached me at the end of one meeting and commented that it appears like they may be “farming to breakeven in 2024.”That comment gave me an idea for a teachable moment on planting decisions and variable costs.
Producers’ decisions on what they plant are based on a variety of factors including crop rotation, yield history, expected market prices, estimated input costs, weather expectations, and availability of credit. Planting decisions are a short-run decision (i.e. decisions that impact the current crop year). On the other hand, long-run decisions impact multiple years (i.e. investing in irrigation equipment). When making decisions in the short-run, it is important to cover total variable costs. Total variable costs for a crop are what it costs to plant, grow, harvest, and market the crop. Producers should calculate their cost of production to help them calculate the market prices and/or yields they need to achieve to cover their variable costs.
Given a producer is able to estimate their cost of production, there are two ways to calculate breakeven. The first is through calculating the price needed to breakeven. Breakeven price can be calculated through the following formula:
Breakeven Price per Unit of Yield = Total Variable Cost per Acre/Expected Yield per Acre
Imagine a producer in Georgia who plans to rent irrigated cropland and grow cotton on that rented land. The producer downloaded the 2024 Irrigated Cotton enterprise budget from the University of Georgia Extension web page to help them estimate the total variable cost at $679 per acre. They are also aware that the Georgia state average cash land rent for irrigated cropland was $234 per acre last year, according to the USDA National Agricultural Statistics Service. With the land rent added, total variable costs are estimated to be $913 per acre. Based on historical production on this land, the producer expects an irrigated cotton yield of 1,200 pounds per acre. The calculation for the breakeven price follows:
$913 per acre / 1,200 pounds per acre = $0.76 per pound
The producer will need to average of $0.76 per pound to breakeven on a projected yield of 1,200 pounds per acre on the rented irrigated land.
The second way to calculate breakeven is through yield. Breakeven yield can be calculated through the following formula:
Breakeven Yield per Acre = Total Variable Cost per Acre/Expected Price per Unit of Yield
The same producer decides to plug in the harvest time futures price for cotton, adjusted for basis, for the expected price. As of the writing of this article, Dec24 cotton was trading around $0.805 per pound. The producer decides to use $0.775 per pound (Dec24 adjusted lower for local basis). The calculation for the breakeven yield follows:
$913 per acre / $0.775 per pound = 1,178 pounds per acre
The producer will need an average yield of 1,178 pounds per acre to breakeven at a price of $0.775 per pound on the cotton grown on that rented land.
Individual producers should keep in mind that their variable costs and cash land rents may differ. Producers are encouraged to utilitze tools like enterprise budgets to help them estimate their cost of production, breakeven prices, and breakeven yields. Understanding breakeven prices and yields can aid producers in management and marketing for the upcoming production season.
Although it is early in the harvest season for many crops grown in the South, it is time to begin revising your annual enterprise budgets in preparation for the 2024 growing season. Enterprise budgets are forward-looking estimates of production costs on a per acre basis for a particular enterprise and production method (e.g, cotton on non-irrigated land).
When it comes to enterprise budgets, direct operating costs are straightforward. If a grower plans to use an input, they specify the amount they plan to use per acre and multiply that by the price per unit of that input. The product is an estimate of the operating cost per acre to charge to that enterprise.
Some overhead costs, also known as ownership costs, are more complex because they are noncash expenses. One may wonder why it is important to charge noncash expenses to an enterprise. There are two reasons for this. First, the use of owned equipment causes wear and tear over time. Eventually, owned equipment needs to be replaced. The loss in value overtime, or depreciation, should be charged to the enterprise for the use of that equipment. Second, the capital invested in the equipment could be invested elsewhere and earn a percentage return on that investment. This opportunity cost, or interest expense, should also be charged to the enterprise.
One effective method of calculating these noncash overhead costs is using the capital recovery method. The capital recovery method enables growers to estimate an annual per acre cost in present day dollars based on the useful life of the equipment used by the enterprise. The following equation can be used to calculate annual capital recovery cost per acre.
-where n represents the useful life of the equipment and i represents the interest rate. The table below lists capital recovery factors (CRF) by year (n) and interest rate (i).
Some row crops are more capital-intensive than others because they require commodity-specific harvest equipment. This is certainly the case for cotton and peanuts in the South. Grain growers need one combine to harvest their grain, and different headers can be switched out to harvest corn, soybeans, and wheat/other small grains. Cotton farmers need a cotton picker or stripper to harvest cotton, and it cannot be used to harvest any other crop. Peanut farmers need a digger/inverter to dig and invert peanut vines and then use a peanut picker to pick the peanuts off the vines. Like cotton, peanut harvest equipment cannot be used to harvest any other crop.
Figure 1 provides an example of annual capital recovery cost per acre at different interest rates for cotton, peanut, and grain harvesting equipment. The appropriate interest rate to select depends upon the grower, their risk tolerance, and desired rate of return on their investments. The average range is between 8-10%, with 9% highlighted on the chart.
The harvest equipment used in this example are based on typical equipment sizes used in Georgia (6-row equipment on 36-inch row spacing) and are assumed to be new. Capital recovery costs can also be calculated on used equipment based on the equation above. Table 1 lists the assumptions on purchase price, salvage value, useful life, and total annual harvest acres. Note, since the harvest equipment is only being evaluated in this article, the tractor has similar total acres to the sum of the peanut digging and picking quipment which are pulled by the tractor, with some allowance for turnaround at the end of the rows. The grains combine is assumed to harvest multiple crops like corn and soybeans.
Table 1 Title: Assumptions on purchase price, salvage value, useful life, and total annual harvest acres.
Figure 1 Title: Sensitivity Analysis of the Annual Capital Recovery Cost per Acre for Cotton, Peanut, and Grains Harvest Equipment.
Chart Source: Author created, using a capital recovery factor table, data on purchase prices, and assumptions on salvage value, useful life, and annual use.
It is evident that cotton and peanuts are more capital-intensive because of the specific harvest equipment and those enterprise budgets need to account for those higher costs per acre. Furthermore, interest rates matter. As interest rates increase, capital recovery costs do too.
While this is only an example for harvesting equipment, this method should be used for each machine used in producing a specific enterprise and added together to determine the total annual capital recovery cost. Table 2 lists a range of capital recovery factors by year and interest rate to aid growers in tabulating these costs on all of their equipment owned by the farm.
Table 2 Title: Capital Recovery Factors (CRF) by Year (n) and Interest Rate (i)
Years ago, at a county production meeting with growers, I was asked by a producer: “When is the best time of year to buy farm diesel?” In other words, he wanted to know if there is any seasonality to farm diesel fuel prices.
Seasonality of prices occurs when there is a time (season) of the year when prices are high or low compared to the annual average price. We typically see seasonality of prices in crops, fruits and vegetables, and some cuts of meat (steaks). An example of seasonality here in Georgia, the price of watermelons tends to be lower during the summer months when local melons are harvested and sold throughout the region. However, during winter months (or Georgia’s off-season for watermelons), prices are higher because there are fewer for sale, and grocers have to source them from other parts of the country or world.
Most often, seasonal indices use monthly data over a 5-year (60-month) period. In the last 5-years, we have had a global pandemic and the war between Russia and Ukraine, which have both affected global petroleum prices and local diesel prices in different ways. Because these events created much volatility in fuel prices, I wondered if they also impacted the seasonal behavior of diesel fuel prices.
Seasonal Indices of Farm Diesel Fuel Prices in the US Lower Atlantic Region for the 60 months prior to the Covid-19 Pandemic and the most recent 60 months.
Chart Source: Author Created with data from the US Energy Information Administration and the Georgia Department of Revenue information on Excise Taxes
The figure shows two monthly seasonal price indices for farm diesel. The first index (orange) was created from data during the five years, or 60 months, prior to the beginning of the Covid-19 pandemic, from January 2015 through December 2019. The orange index can be considered a baseline since it was created from data prior to the pandemic and the war in Ukraine. The second index (blue) is based on recent data from the past 60 months, from June 2018 through May 2023. The solid black line at 100 represents the average annual price over each 60-month time period. When the monthly average index falls below 100, we can assume that prices during that month tend to be below the annual average price (i.e., a better time of the year to buy diesel). When the monthly index rises above 100, we can assume prices during that month tend to be above the annual average price (i.e., not the ideal time of the year to buy diesel).
So how have things changed since the pandemic and the war in Ukraine? Prior to the Covid-19 pandemic, the best times of the year to buy diesel appeared to be August and December. Things have changed slightly in the most recent 60 months with the most pronounced differences occurring in January and March, likely influenced by the invasion of Ukraine in late February 2022 and the steep run-up of diesel fuel prices that followed. Based on the last 60 months of data, the seasonal index suggests a stronger pattern of two buying windows: winter (Dec-Feb) and late summer (Aug-Sep).
Individual producers should keep in mind that these indices are based on historical data and local prices may differ from regional price averages. Future events that cause market volatility may occur and cause prices to behave differently, or a lack of major events might return us to the less volatile pre-pandemic seasonal price trends. Furthermore, any potential savings from bulk seasonal purchases must be weighed against the cost of fuel storage. For producers who already have on-farm storage capabilities for diesel fuel, it may be worth considering purchases of farm diesel during the winter and late summer so they can capitalize on lower prices.
Agriculture is considered a stressful profession, not just because of the complexity of decisions that must be made to successfully run a farm or ranch operation but primarily because there is uncertainty. Whenever uncertainty is involved in the farm business, risks must be taken.
There are five main areas of risk in agriculture: production, marketing, financial, legal, and human. The ability to identify risks in agriculture is the first step in managing those risks.
Production risk is first because it involves the primary livelihood of the agricultural operation. Production risk impacts the ability to produce a crop, raise livestock and poultry, or provide a service. Production risk occurs because of the uncertainty of weather events, pest (weed, disease, or insect) problems, and the availability of inputs – from fertilizers to seed to production technologies.
The second type of risk is marketing. Marketing risk brings the price component into play. Thinking back to when we took basic economics, we learned farmers were price takers who produce similar products. For example, a bale of cotton on your farm is not much different than a bale of cotton in the next county or neighboring state. Furthermore, the prices of agricultural products and inputs are impacted by things happening nearby and globally. Two recent examples include 1) the Covid pandemic, which caused prices to drop for many inputs and commodities, and 2) the war in Ukraine drove prices for some commodities like wheat up, as well as increased in the cost of fertilizer and fuel. These events were out of the producers’ control and difficult to predict.
The third type of risk is financial. Financial risk involves the ability of the operation to cash flow and gain access to capital to maintain and expand the operation. In today’s environment, financial risk is impacted by inflation and interest rates. Inflation makes inputs “more expensive” to buy, and consumers are unable to purchase as much with their dollar. In addition, the Federal Reserve has increased interest rates to try to get inflation in check. Higher interest rates result in a higher cost to borrow funds. Farmers are seeing higher interest expenses, even without expanding their operations.
The next area of risk is legal. Legal risk includes the knowledge of, and compliance with, regulations and laws related to the production and marketing of agricultural products and services. A recent example has been with the ability to apply dicamba herbicides which are regulated by the United States Environmental Protection Agency. Although laws vary by state, any certified applicator who plans to apply dicamba herbicides must be trained specifically on their application to ensure label compliance and stewardship. This training must be completed annually and prior to the use of any dicamba herbicides. Legal risk also encompasses the other two areas of risk: financial (requirements to follow the terms of debt) and human (labor rules and regulations). Those who do not comply with laws and regulations will be subject to liability. Liability occurs when a person or entity is held legally responsible for any potential damage or losses that result from the non-compliance.
The final area of risk is human. Although listed as the final area of risk, the figure shows it as the topmost circle in the stack of risk circles – meaning it is one of the most important areas of risk. Human risk involves the people of the agricultural operation, from management to employees to future heirs. Human risk includes the health and well-being of the people who maintain the day-to-day operations. It should also include plans to transition the operation if a change in management were to occur.
For more information on risk in agriculture and how to manage it, refer to the handbook linked in the resources, titled: “Introduction to Risk Management. Understanding Agricultural Risks: Production, Marketing, Financial, Legal, and Human.”
Five Types of Risk in Agriculture
Figure Source: Author compiled.
Resource: Crane, L., G. Gantz, S. Isaacs, D. Jose, and R. Sharp. “Introduction to Risk Management. Understanding Agricultural Risks: Production, Marketing, Financial, Legal, and Human.” Extension Risk Management Education Programs and USDA, Risk Management Agency. Handbook Second Edition, 2013. http://extensionrme.org/Pubs/Introduction-to-Risk-Management-ENGLISH.pdf
