Start thinking about where to cut costs to protect working capital

DUBUQUE, Iowa — Many farmers are in a strong financial position following several years of high commodity prices.

"But eventually, if we continue to see prices of $4 and below for corn and $9 and below for soybeans, there will be cash flow shortfalls which will lead to working capital reductions," said Gary Schnitkey, University of Illinois agricultural economist, at the recent Tri-State Lender's Seminar in Dubuque. "Eventually those working capital reductions will cause working capital to go away and then we'll have to make some decisions. For some farms it might be this year. Other farms will be able to put that off."

Looking at budgets for 2016, with $4 corn and $9 or below soybeans, costs need to be cut $100 per acre, and cash rents have to be part of that, he said.

Farmers and landowners should consider variable cash rent, Schnitkey said. A base cash rental rate is established and if corn and bean prices go up, the revenues can be shared between the renter and the landowner.

Data from the Illinois Farm Business Farm Management Association show net farm income on grain farms peaked at close to $300,000 in 2012. From 2010 to 2012 net farm income was over $200,000 per farm. In 2013 and 2014, net farm income averaged $125,000. It is projected to be close to $20,000 per farm or lower in 2015.

The reason for the big decline from 2014 to 2015 is marketing gain on 2013 crop sold in 2014, Schnitkey said. Also, yields in Illinois in 2014 were exceptional and will be down in 2015. Lower income in 2015 will be repeated in 2016 with $3.80 corn and $8.85 soybeans used in 2016 budgets.

The financial strength of these IFBFM farms is very strong, Schnitkey said. From 2006 to 2013, the farms saw an increase in intermediate asset values from $400 to $1,100 per acre.

"Much of that was machinery," Schnitkey said. "We bought every piece of machinery that could be bought. We could run machinery three to four years without purchasing any new piece of machinery on many farms."

Debt to asset ratios declined to 0.2.

Working capital, or current assets relative to current liabilities, increased from 2006 to 2012, Schnitkey said. It averaged 1.7 prior to 2006 but was close to 2.5 in 2012 and has come back down in 2013 and 2014. Working capital per acre was more than $700 in 2012 and has been coming down in 2013 and 2014. Part of the reason it came down was lower grain inventory values. A slight erosion was seen in cash balances on farms in the end of 2013 and 2014.

"Overall there is a lot of financial strength, but another year or two with cash flows like we've seen would take us back to a working capital position back to the 2000 to 2005 period," Schnitkey said.

Working capital losses in Illinois in 2015 are projected at $11 per acre for owned land, $171 per acre for cash rent land and $72 for share rent land.

"Increased costs and lower prices brought even 50/50 share rents into a negative situation," Schnitkey said. "Farms with the most cash flow issues will be those renting most of their land and paying high rental rates."

Schnitkey said if cash flow problems aren't fixed, they will continue to erode working capital.

There are farmers who are going to "burn cash now," taking losses to avoid losing rented land in hopes prices come back . They are opting to wait for $4.50 corn and $10.50 soybeans.

"I personally think that's a risky strategy," Schnitkey said, adding that his analysis shows that even with $4.50 corn, $10.50 soybeans, farmers must cut costs.

"We could be at $4 corn and below for a while," Schnitkey said. "If you plan for $4.50 corn and $10.50 soybeans for a long-run price, you still need to cut costs."

Current costs allowed a profit when corn was $5 but not with $3.85 corn.

Schnitkey's 2016 budget shows the need for a $100 per acre reduction in costs. Cuts need to come from rent, fertilizer, seed, machinery depreciation and pesticides.

Fertilizer prices are likely to go down by about $15 per acre, Schnitkey said. Seed prices aren't dropping unless farmers are willing to take deals that will reduce costs $10 to $15 per acre. Machinery depreciation will come down only if farmers make less capital purchases. Slight declines were seen in Iowa and Illinois in cash rental rates in 2015.

His 2016 northern Illinois budget shows that with a $50 reduction in cash rent and a $50 cut in non-land costs there are still no profits at $3.85 corn. If prices remain below $4 for corn and $9 for soybeans, cash rents would have to fall $100 acre with a $50 cut in non-land costs.

"If you don't believe my budgets, do your own," he said.