Steps to Mitigate Financial Risks on the Farm
Recently, the following questions were posed to some of our more seasoned staff at Farm Credit: (1) If you could identify a significant risk to a producer being successful and preserving their agricultural investment for the next generation what would it be? (2) What measures did these producers take to mitigate these risks?
The answers were varied but fell into one of three categories: Financial Condition, Risk Management, and Planning for the Future. Let’s dive into some detail on each of these categories. Keep in mind that this is not an exhaustive list. There may be as many risks as there are individual operations.
Ø Controlling Debt Levels – In a commercial agricultural operation debt is more often than naught a necessary tool for your success. However, viewing debt from a proper perspective can keep you out of trouble.
o Debt must be conservative, constructive and thought-out.
o Analyze, using average historical prices, how much debt your operation can support and make capital expenditure decisions based on that analysis.
Ø Growth and Expansion – With input costs increasing year after year it is true that if an operation is not growing then it must be shrinking. Growth and expansion plans into the future should be part of your strategy but how to grow should be measured and planned. Growth in an operation can come from three sources:
o Funding your growth from the net profits of your operation is a slow process but you avoid adding additional debt.
o Financing your growth with a loan is reasonable but the level of debt should be tied back to the production of your operation. In other words, your debt should be at a level that can reasonably be supported by the net income from your operation. Using average historical prices in this analysis will keep you from burdensome debt levels.
o Your rich uncle (partner) can be an option to fund your growth but he may not be as “silent” a partner as you would like.
Ø Consistent and Timely Financial Tracking – Just as your banker uses financial statements as his tools, you too should consider financial information as valuable tools to help you preserve your investment.
o Utilize balance sheets, earnings statements, budgets and financial ratios to track trends in your business.
o Knowing your cost-to operate will enable you to determine your break-even price which is critical to know as you make operational and capital expenditure decisions throughout the operating cycle.
o Preparing an annual budget can be an invaluable tool to track progress and help you identify negative trends sooner.
Ø Controlling Living Expenses – Determining what your true living expenses are can be difficult but will help you plan and budget appropriately.
o Determine how much your operation can support and budget accordingly.
o If additional family members become involved in the operation are there enough profit margins to support them?
o Not understanding and budgeting for your living expenses can lead to non-constructive debt levels rising.
Ø Utilize Professionals to Help – There are experts such as Certified Public Accountants, Financial Planners and your Banker who can help you through this process. Once you pay the price to set up your financial monitoring system you will soon realize you can’t operate without it.
Ø Controlling Volatility in your Operation – As we said before, there are some things that are outside your control but there are tools available to flatten out the peak and valley volatility that can plague your operation.
o Hedging or Forward Contracting your production and inputs can lead to more consistent prices over the long term and can help with effective budgeting and planning.
o Having the mindset that ‘a smaller profit now is a reasonable alternative to waiting for higher prices’ can also control volatility. This is where knowing your break-even price is critical to making an informed decision.
Ø Interest Rate Risk – Interest rates are on the rise after many years of being at historically low levels. There is no doubt you have benefited from these low rates. Now a measure of protection may be in order.
o Perhaps it is time to consider fixing some of your longer-term loans. Talk to your Banker and make sure you understand the cost to fix a rate and if there are any fees to
o If you wait until short-term rates move higher you may miss an opportunity to fix at a lower rate.
o One thing to consider as you are assessing your financial condition is that the historically
Ø Preparing for the Unknown – Running a commercial agricultural operation brings life and liability risk beyond other industries. There are tools available to protect yourself from unfortunate events.
o Life and liability insurance policies not only protect you but also those that would be left behind if the unfortunate did occur.
o The use of legal entities such as partnerships, corporations, and limited liability companies can protect your personal assets from liability incurred by your business operations and it can protect your business assets from liability incurred personally.
Preparing for the Future
Ø Don’t Wait! – Time can be your greatest ally or your fiercest foe when it comes to planning for the future. If your ultimate goal is to preserve your agricultural investment to pass to the next generation there are things you can do now to accomplish that.
o As a family visualize the end that you want and start asking questions.
o Involve all family members/stakeholders in developing your plans/goals. Be sure to include all family members in the discussion.
o Those you have determined are next in line to take over the operation should be involved early on so they can become familiar with the management and marketing side of the operation and began to establish their own personal relationships with key industry contacts.
o Analyze every scenario and make contingency plans for them.
o Effectively communicate often with family/stakeholders.
o Once you have created your plans and goals don’t ignore them. Make changes as things within the family dynamic change.
Ø Tools to Utilize – There are resources available to help you map out your plans and to put them in writing.
o Don’t do this on your own. Professionals such as CPA’s, Attorneys, Financial Advisors, Insurance Agents
o Wills, Trusts, and Powers of Attorney are tools that will help you put in writing the plans and goals that you have created. These will be available to every family member so they can refer to them as often as they need to.
o Buy-sell agreements and life insurance are important. Mortality has a way of creeping up on all of us and those that are left behind may not have a desire to stay in the operation but may have a financial interest in it. Having an agreement in place before that happens and having the capital to execute it may be the best decision you ever made.
o These tools come with a cost; however, consider them a cost of doing business. They can ultimately be just as critical to the long-term success of your operation.
We’ve discussed just a few risks that can be present in your operations. The goal is to get you thinking about your operation and whether any of these apply to your situation. By virtue of just thinking about these issues has put you on the right path. Now it’s time to act! Planning and preparation now can pay huge dividends down the road and put you well on your way to preserving your investment for generations to come.Join Our Family