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PURDUE ECONOMIST ON THE DETERIORATION OF FARMERS' WORKING CAPITAL
Source: blog by Michael Langemeier, Center for Commercial Agriculture, Purdue University

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Introduction

Working capital represents the liquid funds that a business has available to meet short-term financial obligations. The amount of working capital a business has is calculated by subtracting current liabilities from current assets.

Current assets include cash, accounts receivable, inventories of grain and market livestock, prepaid expenses (e.g., feed, fertilizer, and seed inventories), and investment in growing crops. Current liabilities include accounts payable, unpaid taxes, accrued expenses, including accrued interest, operating lines of credit, and principal payments due in the upcoming year on longer term loans.

Working capital provides the short-term financial reserves that a business needs to quickly respond to financial stress as well as to take advantage of opportunities. It provides a buffer to financial downturns that might impair the farm's ability to purchase inputs, service debt obligations, or to follow through on its marketing plan. It also provides the financial resources to quickly take advantage of opportunities that might develop (e.g., rent additional ground; purchase land; add a family member to the operation).



This article discusses recent trends in working capital and differences in working capital among farms, and provides working capital benchmarks. Data from USDA-ERS, the Kansas Farm Management Association, and the Center for Farm Financial Management in Minnesota is utilized.

Working Capital Benchmarks

How much working capital does a farm need? The answer to this question depends on both the risk and size characteristics of the farm, and volatility of the business climate. In a volatile business climate and when a farm engages in enterprises that exhibit relatively more variability of net returns, more working capital is needed.

Larger farms also need more working capital, so it is best to determine the amount of working capital buffer relative to either gross revenue, value of farm production, or total expense. Working capital to gross revenue, working capital to value of farm production, or working capital to total expense ratios above 0.35 are commonly used thresholds by financial analysts and would be considered an adequate level of working capital to weather a one- or two-year downturn. When the working capital ratios fall below 0.20, a farm may have trouble repaying loans.

Trends in Working Capital

Figure 1 illustrates the trend in working capital for the U.S. farm sector since 2012. Working capital dropped from $165 billion in 2012 to an estimated value of $52 billion in 2020. The largest drops occurred from 2012 to 2015. Working capital has been below $75 billion, or less than one-half of what it was in 2012, since 2016.


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