The agricultural industry can be particularly volatile and with the economic uncertainty caused by Brexit being compounded by the effects of Covid-19, it has never been more important to consider and assess the liquidity of your farm business.
Working capital is a financial metric representing operating liquidity of a business and its ability to generate cash in order to pay short-term financial obligations. It can be calculated in two ways:
Net working capital is calculated by subtracting current liabilities (accounts payable, short-term debt repayments etc.) from current assets (accounts receivable, stock, cash and cash equivalents etc.), and is normally easily identified on the balance sheet as ‘net current assets’.
The current ratio is calculated by dividing current assets by current liabilities. A business that is considered liquid will have a current ratio of 1.2 to 2.0, with current ratios of less than 1.0 indicating a potential short-term inability to meet debts as they fall due.
Below is an extract from an example balance sheet and how working capital metrics are calculated:
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Current Assets
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Current Liabilities
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Stock
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25,000
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Trade creditors
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4,500
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Bank current account
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1,500
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Accrued expenses
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6,500
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Bank savings account
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25,000
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Loan repayments (< 12 months)
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10,500
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Trade debtors
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3,500
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HP repayments (< 12 months)
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9,500
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55,000
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31,000
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Net working capital
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Current ratio
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Current assets - current liabilities
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Current assets/current liabilities
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£55,000-£31,000 = £24,000
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£55,000/£31,000 = 1.77
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Timing is important when considering working capital levels. Farming businesses, along with many others, will often experience fluctuating levels of working capital and liquidity throughout the course of their financial year. The balance sheet on your financial statements will provide an accurate indicator of working capital at the year-end date, but if you fear there may be impending liquidity issues then gauging an estimate of your current level of working capital may be worthwhile. This can be achieved by using your most recent balance sheet and adjusting the figures for the current position of your farm. Check your bank balance(s), stock levels, outstanding invoices, and debt repayments due within the next 12 months. Then, using the metrics outlined above you can estimate of your farm’s net working capital and current ratio.
It is important to regularly assess and in turn maintain, good levels of working capital as this allows you to plan ahead. Understanding your business’ working capital and how it fluctuates throughout the year, will help decisions to be made regarding the timing of asset purchases, major repairs, expansion plans, etc, while at the same time highlighting any requirement for short-term funding.
Gordon Armstrong MA (Hons)
gordon.armstrong@renniewelch.co.uk
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