As crop farms start to think about spring planting, there’s a lot you have to focus on. Over the next couple weeks, I’ll be asking you to consider a couple areas of your farm’s financials – a few things that make a big impact, because they’re the foundation of your financial condition.

I often talk about how the there are four areas where you can impact your farm business the most. When you list them in order of biggest impact, they are: production, having the right crop insurance for your operation, marketing well, and having a strong understanding of your farm’s financials.

Keep eye on your farm’s liquidity over next few years

Since this blog focuses on farm financials, I’ll be looking at several key things to watch and dig deep into over the next few weeks. In particular, if your farm is beginning to feel a financial pinch – or you’re projecting that you may after 2015 – you’ll want to learn and get a good grasp of these ideas.

Working on working capital

A key component of knowing your farm financials deeply is understanding your working capital, how it can affect your operation and what you can do to impact it. Your working capital is a status that shows you – and your bank – how your operation is doing.

It shows the level of liquidity your operation has. We recommend that our clients strive for – and maintain – a working capital ratio of 40%.

If you focused on building your working capital over the past few years, then you’re probably in a good position with your liquidity. You’ll likely be able to take advantage of opportunities in the next couple years.

Strong working capital may even let you influence some of your costs a bit. For example, if you prepay your seed using cash, you can typically receive a discount.

Watch the burn

Something to pay close attention to – particularly if your farm could be facing a loss situation – is the burn rate on your farm’s working capital. The burn rate is figured by taking your working capital and dividing it by your projected net cash loss (if you have a positive working capital number). That tells you how many years are left before you would be out of working capital.

For example, let’s suppose a farm has $100,000 in working capital. They are projecting a net cash loss for 2015 – a $50,000 loss. Their burn rate shows that they have one year left after 2015, because if they have another loss year of $50,000, their working capital will be gone.

Obviously a burn rate of a year or two creates a very urgent situation. The key is to understand what you’re facing, so your awareness leads you to make the right decisions. If you’re already faced with negative working capital and a projected net cash loss for the year, you’ll likely be taking from any residual equity in your business.

With a working capital cushion of 40%, your risk of ‘burning up’ your liquidity is much lower. You have more margin for the unexpected. You’d be able to withstand a bad year. That working capital protects your farm as you weather the storm.

Work on understanding your burn rate on working capital, whether that’s figuring it out on your own or working with a financial consultant. Then use what you’ve discovered to make smart decisions for your farm.

Next week, I’ll look into how you can get a grasp on your farm’s return on investment in different areas of your operation. Until then, read more articles on farm financials in our Smart Series publication – bringing business ideas for today’s farm leader or on waterstreet.org.

Marketing is not for everyone and you should always evaluate your risks.

The opinions of Darren Frye are not necessarily those of Farm Futures or the Penton Farm Progress Group.