Written by Kelly Farrell of Farrell Growth Group
The most common topic of discussion related to inflation has been record fertilizer prices, but other input costs are up as well. And it’s not just an increase in prices. Supply concerns have retailers building up inventories to prepare for the spring, and ag retail balance sheets carry those sharp increases in inventories.
Higher inventories—and subsequently, higher receivables—can result in significant increases in working capital requirements—the money a company uses to fund its operations. Higher working capital requirements can mean additional borrowing and a higher resulting interest expense, which is a drag on profitability. Strong working capital ratios are key to favorable borrowing rates, so a decline in working capital can result in a higher interest rate.
Here are four things you can do to decrease your company’s working capital requirements:
1. Encourage Prepays With Customers
Additional funds brought in through prepays will be reflected as current liabilities on the balance sheet, which has the effect of decreasing working capital requirements. Prepays allow you to use those funds to finance your operation rather than borrow that money from a bank. Of course, prepay discounts will pull down margins, so you do need to weigh the cost with the benefits. Keep in mind you may not be able to supply everyone this spring as you have in the past. Start communicating that to your customers. Expanding your prepay programs and tying them to contracts for the product your growers know they are going to need lowers your inventory risk. At the same time, it eases strain on working capital.
2. Consider Adjusting Your Policies Related to Receivables
Now would be a good time to tighten up your procedures related to receivables. Concentrate on collecting receivables more quickly. Lower receivables mean lower working capital requirements. Additionally, consider the option of outsourcing your receivables, which would increase your cash position and remove those receivables from your balance sheet. This would improve your working capital position.
3 Negotiate Longer Terms With Suppliers
It would be worth the effort to try and share the increased risk of volatility with suppliers. Improving terms with suppliers will allow you to increase payables, which in turn will decrease working capital requirements. Of course, with supply challenges, extended terms may not be available on all products. However, you may find opportunities to extend terms on certain products.
4 Communicate Proactively With Your Bank
Increases in inventories and the subsequent increase in working capital needs could impact your bank covenants—the ratios that banks monitor to evaluate the strength of their customers’ balance sheets. A decline in your company’s ratios could result in higher interest rates on your operating line. Additionally, as inflationary pressure continues, the Fed may decide to raise interest rates. Stay in close contact with your lender, so there are no surprises.
