As we transition from strong summer cash markets, we reflect on healthy year-to-date profits. Iowa State University’s Estimated Livestock Return Summary reports an average profit of $19.36 per pig through July of 2017. These profits have continued to support the impressive balance sheets U.S. hog operations have built in recent years. The question posed to us as lenders is, “Is there such a thing as too much cash in a hog operation?”
As a lender, the typical answer to this question is “no.” However, the correct answer should be “yes.” With any trusted adviser, great questions are answered with great questions, starting with “How much cash should you have?” We have all heard the cliché that “Cash is King”. As producers manage their financial position, it is important to have the right amount of cash and an overall working capital that takes into account future growth plans, industry profit cycles and the risk appetite philosophy of your business.
What are your future growth plans?
If your business is in a mature segment of its life cycle, your need to retain cash inside the company is rather small. If your one- to three-year plan is to expand operations, adding sows and market hog inventories, barns, a feed mill and a truck wash, your need for cash is much greater.
The best producers we work with have a long-term planning model that illustrates the impact of growth strategies on paper. Modeling growth gives clarity to the business’s capacity to fund expansions, while maintaining a sound financial position. Owners appreciate the clarity these models bring, as they manage cash resources in the months and years leading up to the pending projects.
Get more INSIGHT: Download 6 Ways to Manage Risk on Your Hog Farm now!
Where do you believe we are in the industry profit cycle?
When you look back at the profits and losses that producers have faced over the last 20 to 30 years, there is clearly a cycle that is exhibited. While the laws of economics take time to play out, there are extreme profits and losses along the way. Having an awareness of where the industry is at within the cycle, and more importantly how you are positioned relative to your peers is important.
I always tell people that when a drought hits, you need to have a well full of water to live off of, or at a bare minimum, you need to have a well to go to. When I look at cash, I see that as water in the well. When I look at having a well to go to, that is having your credit facility structured properly in advance, that way you have lines of credit already in place to sustain your business through difficult times.
At Compeer, our borrowers are commonly set up with a primary operating loan, as well as a real estate revolving line of credit beyond their long-term loans that finance barns and land. Having the revolving lines of credit in place allows borrowers to pay down debt when cash positions are strong, but to retain the ability to borrow against the line when additional cash is needed. This saves interest expense while retaining access to cash.
Risk appetite philosophies
We work with producers who range across the spectrum of risk appetite. Most producers have a risk management strategy that protects them from a catastrophic event. However, the level of coverage and the strategy designs vary greatly. Producers with strong cash and overall working capital positions have the ability, if they so choose to use it, to take on more risk.
There are periods of time where future profit margins are not at targeted levels. When the balance sheet is in a tighter position, businesses may need to make the responsible decision to lock-in less than desirable profit levels. In some instances, the question is, “Should I lock-in a small loss to avoid a potentially significant loss if markets deteriorate further?” These decisions ensure that the business will be protected from adverse turns in the market. It also provides them with the opportunity to move forward with long-term plans. Operations with sound capital positions can determine if they need to lock-in marginal profits or to instead wait for improved margins. They do so knowing their cash position would cover any adverse losses that they may incur if the improved margins fail to be presented.
In all, managing cash levels is important; but similar to all management practices, there is no one-size-fits-all solution.
Timmerman is a senior swine lending specialist for Compeer Financial. For more insights from Timmerman and the Compeer Swine Team, visit Compeer.com.