Managing your liquidity ratio during the crop year
By ATB Financial 28 May 2020 2 min read
From extreme drought in the south, to excess moisture in the Peace, and snow in September across the province, the last two harvests were a challenge for grain farmers across Alberta. As a result of these events, and now in the wake of COVID-19, many producers across the province may start to see increased pressure on farm finances as operations continue to be challenged by disruption.
To be prepared, one topic worth discussing is liquidity.
What is liquidity?
Simply put, liquidity is the amount of current assets that are available to pay expenses and debts as they come due. On a farm, those current assets include cash, accounts receivable, and inventory. Current liabilities include crop input loans, operating lines, and principal payments on term loans.
A good benchmark is to have at least $1.50 in current assets available for every $1 of current liabilities that need to be paid in the next 12 months. The lower that ratio gets, the tighter your working capital is, leaving little room for the unexpected.
After a couple of challenging crop years, current liabilities may begin to creep up, putting pressure on that ratio of current assets to current liabilities. Strong liquidity gives you the ability to withstand short-term shocks and the ability to realize on opportunities. As we head into a new crop year, it’s important to check the financial pulse of your operation and liquidity is a natural starting point.
Examining your ratios
What happens if you take that pulse and the ratio is upside down?
“It’s really about communicating with your banker,” says Jonathan Neutens, Vice President, ATB Agriculture. “Things are going to happen that are outside of your control, but it really comes down to that conversation, understanding your specific circumstances and then figuring out what financing options and activities might help.”
Examine where your ratio is today. Is there a shortfall? A surplus?
Next, it’s prudent to understand the need and timing of cash in-flow and out-flow. Are your planned crop sales timed around when you need to make payments?
Clearly understanding the ratio and how it is impacted by timing is a great first step in preserving your liquidity and keeping a strong balance sheet. Calculating your current ratio during the growing season will almost always result in what appears to be a negative, because inventory levels are at their lowest and there is a huge investment in the growing crop. The best time to evaluate is immediately after harvest.
"Through an end-of-season evaluation, you will gain a much clearer picture of where you stand in terms of working capital, and from there you are better able to plan for the coming months," says Neutens.
Contact your ATB Financial Relationship Manager to learn more about liquidity, take your financial pulse and find out what options are available for you and your farm.