Partial liquidation or restructuring debt may help some producers weather the low hog cycle.
One quarter of back-breaking hog prices is taking a toll on many hog enterprises. Current hog prices are not covering most farms' operating expenses and debt service. This shortfall in working capital makes lenders and suppliers nervous, possibly leading to liquidation of assets or debt restructuring.
The issue here is a lack of working capital. What can pork producers do about a loss of working capital?
Financial management specialist Allen Lash recently addressed that question and others regarding working capital during a National Pork Producers Council teleconference.
"A lot of producers have used all of their working capital to expand their hog operation," Lash acknowledges. "And when they hit a time like now, with low prices and inadequate profits, they don't have that cash or liquidity cushion. Some are just forced out of business."
On the other hand, hog operations with enough working capital can ride through tough times, he adds.
What Is Working Capital? Strictly defined, working capital is the difference between current assets and current liabilities. Current assets include the assets normally sold in a 12-month course of business while current liabilities is the debt that will have to be paid in a 12-month cycle.
Lash says nearly all lenders have those two items on the same line so they can be quickly subtracted, telling the lender if the farm has more liabilities or assets.
Working capital pays things like a hog farm's operating losses, family living expenses and debt service. It also is used for expansion or prepayment on debts.
"Obviously, a business should want more cash available over a 12-month period than they are going to have expenses, or they will run out of money," Lash explains.
From a lender's perspective, low working capital means debt won't get paid. This usually forces a producer to make changes to improve working capital.
Gaining Working Capital The options to improve working capital at a time like now are not plentiful. He offers three viable options:
1. Partial liquidation - Lash says this is one of the best ways to improve working capital today. He suggests producers find the least productive assets and sell some of those to pay down current liabilities.
"We know from past experience that most producers can sell 15-25% of their assets without dramatically impacting revenues and profits," Lash reports.
What should be liquidated depends on each producer. Producers with a strong commitment to pork production might look at liquidating crop assets, for example. "Farmland has such a poor asset turnover and very little ability to generate revenues that an operation may need for cash and expansion," he explains.
Other operations may look at liquidating one part of their production enterprise. For example, a producer interested in finishing only may want to liquidate their farrowing enterprise.
2. Add equity - Another method to improve working capital is adding equity. For a sole proprietorship, gifts or an inheritance will add much-needed equity. In a corporationor partnership, the owners or partners put in capital.
3. Restructure liability - Producers can restructure their current debt into non-current debt by obtaining 3- to 10-year loans. Lash says this option merely buys time for the producer to solve their debt problem.
Lash adds that there are two other methods to reduce working capital problems; neither is a good option now. One is to generate more profits. But, when producers are losing money in a low hog cycle, this is not a possibility. The other method is writing down debt. Lenders shun this option. It should be reserved for bankruptcy court.
Working Capital Minimums Pork producers should achieve minimum levels of working capital, depending on the size of their hog operation. Lash suggests several minimum levels, which are higher than many lenders may require.
"Producers must protect themselves from things like disease, economic cycles, and those kind of problems," he explains. "Otherwise, when they run out of capital, they are unable to stay in business."
He suggests a farrow-to-finish operation look at 30% of annual revenue for working capital. For example, an operation with $500,000 in annual revenue should have at least $150,000 of working capital.
On a per-sow basis, Lash says about $500-600/sow is a good working capital level. So a producer adding 100 sows to a herd should shoot for $50,000-60,000 in additional working capital.
Farrow-to-nursery operations need working capital equal to 40% of annual revenues. The working capital needs for a farrow-to-wean operation is at least 30% of revenue.
Producers purchasing early weaned or nursery pigs should look at 40% of revenue for working capital.
When the hog cycle starts to head back up and producers look at expansion, Lash offers some timely advice: Don't use all your liquidity for expansion. He recommends producers maintain the working capital minimums just outlined. New producers need to arrange for working capital through their lender. Lash says they should get a commitment from the lender to provide adequate working capital.
Following minimum working capital guidelines should help producers weather this and other troublesome hog cycles.