The other day I was listening to another financial speaker discussing strategies for these turbulent economic times. His quote was, “Working capital is the first line of defense against price volatility.” Let’s ponder this statement, given the current and future economic situation of lower margins and increased volatility.
First, working capital is one of the most misunderstood financial metrics. Many producers are under the impression that working capital equates only to cash. Working capital is a measure of liquidity calculated by subtracting current liabilities from current assets. These current assets are not limited to only cash and include assets that can be turned into cash without disrupting normal operations within a year. Current liabilities are your financial obligations that are due within the next year.
Excess working capital allows for increased flexibility in the marketing program. A pen of cattle or bin of grain can be marketed in a more optimal timeframe to generate stronger net margins. Working capital allows one to self-finance short-term business strategies and tactics rather than totally depend on lines of credit that may be due for repayment. A strong working capital position allows one to take advantage of cash discounts and negotiate expenses and capital purchases, which can make a large difference on the bottom line.
I would like to embellish the speaker’s comment further by stating that working capital is also the first line of defense against asset volatility. If one has extra working capital assets such as equipment and livestock, then they are not forced to sell in a depressed market. The other side of the coin is that working capital can be used to purchase assets at discounted prices in a down market.
The book, "Great by Choice," by Jim Collins addresses working capital and cash in one of the chapters. He stated that working capital is a critical element that separates one set of business owners from the others. Owners who manage working capital are more financially profitable over time and build wealth in their business.
In conclusion, working capital and cash are powerful tools in building profits, cash flow and wealth. One only has to examine Warren Buffett to see the power of working capital. He maintains excess resources to pounce on deals, of course with a few extra zeros and commas on the balance sheet.