Managing Receivables in an Animal Feed Business

Managing Receivables in an Animal Feed Business

The implications of accounts receivable are far reaching for all firms. A firm that relies very heavily on capital like an animal feed business can be "made" or "broken" in how well the managers of the business deal with accounts receivable. There is no doubt that many industries operate much like a gear, in that each cog is vitally important with regard to how successful the other businesses in that industry perform. In agriculture, the culmination of market prices for commodities such as milk, meat, and grain can be felt all the way to the animal feed manufacturer who provides the necessary daily sustenance to the end user, the cattle. As milk or cattle prices plummet below the break-even point for the farmer or rancher, a shock-wave is sent through an industry that continually sees consolidation and long-time businesses fall off the map. The dairy industry in particular is an input intensive sector of agriculture. Dairy farmers can spend as much as 50% or more of their revenue on the procurement of feeds for their cattle. As a result of this fact, the market prices of both grain and a dairy farmer's main revenue stream, milk, can have a significant impact on not only the dairy producer's bottom line but also his suppliers'. Tradition in the dairy industry, particularly in the Northeast United States has been for the feed supplier to "carry" the dairy producer when the all too common plight of rock bottom milk prices and/or sky high feed prices hamper a dairy's ability to break-even. A more sound understanding of accounts receivable and the numerous spokes that ultimately make up this wheel, has inevitably caused some feed suppliers to "buck" this tradition of "carrying" unprofitable dairy farms through more prudent analysis of accounts receivable.

Working capital is of great concern for any business that employs large amounts of cash and turns their inventory over very quickly in order to keep the flow of their business uninterrupted. This is especially true of a feed manufacturer that must continuously purchase large amounts of ingredients to keep their "pipe-line" full for the customers' cattle the business ultimately serves. Since accounts receivable is listed as a current asset on the balance sheet and working capital=current assets current liabilities, it becomes clear that a foundational understanding with regard to accounts receivable is vital to making sound management and investing decisions. This concept became particularly clear in the summer of 2008 when corn and soybean prices soared, nearly doubling the amount of capital a feed manufacturer needed just to keep the mill running and proportionally increasing the cost of those inputs for the dairy producer. Some feed mills found that their poor management of accounts receivable left them in such a poor cash position that continuing to manufacture feed became impossible without restructuring or selling out.

The matching and proper evaluation of receivables can ultimately become the component of the financial statements that may determine how well management directs the business toward profitability. Matching of receivables really begins when the feed company extends credit to customers in order to allow them to purchase the merchandise, in this case let's say the feed for the milking cows. The minute that credit is extended, a prudent manager knows roughly how much is going to be paid back and how timely those payments will be made. The highest performing managers may even take into account the climate of the dairy industry as a whole and adjust the firms' collection practices in an effort to insulate the mill from the aftershocks felt by volatile farm level prices. The amount that will not be paid is called bad debt expense and top-notch managers take the necessary steps to minimize this loss and see that all debts are recovered in a reasonable amount of time. This valuation adjustment is an estimate of the accounts that will go unpaid. For example in the feed industry, a manager might expect that for accounts that are 30 days past due 97% of those customers will pay in full. As customers' accounts reach 60 days past due, only 90% of those customers will pay their outstanding debt. By accounting for this bad debt expense within the accounting period, feed manufacturers are employing the matching concept. The matching concept as applied in this example allows managers and investors to more accurately state net income, return on investment, and return on equity.

Accounts receivable is clearly a necessary evil in nearly all businesses. As a result of the working capital intensive nature of a business that must turn its inventory very quickly, collecting unpaid debts is vital to maintaining the necessary liquidity to keep the rail cars of ingredients flowing into the receiving bays. If the customers that are served by a feed manufacturer struggle to stay current, then one could deduce that the feed mill would be required to borrow more money and thus incur more interest expense. The poor management of accounts receivable has far reaching consequences for the financial performance of the feed company.

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