The Margin Squeeze: Managing during Financial Stress

Introduction
Nebraska farmers, among others are experiencing a new cost-price squeeze unlike that of the farm crisis of the late 1970’s to the mid 80’s. During that farm crisis, interest rates, reduced crop demand and rapid land devaluation financially pressured many leveraged farmers. The current farm profitability squeeze is different. Current interest rates are near historic lows, debt exposure for most farmers is low and corn demand is consistent due to the domestic ethanol industry. The current environment is due to losses incurred from crop production or due to costs not yet aligning with revenues.
Three areas are crucial for farm operators in the current economic environment. The primary area to focus on is “managing income and cash flow” The next two are liabilities management and assets management.
Discussion
Cost control over the next few years will be critical factor in surviving the next few years. Costs, land costs, seed, fertilizer and machinery, rose rapidly in the last few years, but have not begun to decline yet. Gary Schnitkey, U of Illinois Ag Economist, reviewed what happened during previous periods similar to this. Schnitkey found that costs only drop back by 18% from their peak and take several years for the adjustment declining on average 4% annually. Simply cutting costs with an axe doesn’t make sense though. Rather when reviewing your costs ask yourself whether the money invested is giving a return above cost. Some things may make sense to do at $7 corn when the return doesn’t exist at $3.50 corn. When looking at the return, look to data that is trustworthy and not testimonials about a product. You can only analyze returns using reliable data.

Rental arrangements will be re-negotiated in the coming years. Rental rates are one of the largest costs items in crop production. Current crop production costs are above reasonable projections of crop revenues, including Farm Bill program payments. Very little can be done to reduce non-land costs of production, seed, fertilizer, pesticide, without effecting productivity and revenue. Which leaves rental rates, the residual claimant on crop revenues. Renegotiation may include reductions in cash rent, a move to crop share or establishing a flexible rent. Flexible rental agreements can give the landowner a base rent but also the possibility that if yields and/or price do better than anticipated, the landowner can share in that.

Recent profitability in crop production has allowed many farm operators to update machinery. A few may have made those updates for tax reason. But now a period of financial stress is taking place. Thus the next few years aren’t pointing to buying but rather repairs and renting or custom operations. Excess capital investment in machinery should be evaluated and possibly sold to eliminate cash outflows.

A reduction in family living withdrawals may be necessary as well. Some of these may be difficult to do and some may be inadvisable, such as dropping health or life insurance. Bu assess your living expenses to determine where reductions are best taken.

Look for areas of increased revenues or throughput. Look for those capital assets that could generate income above variable or cash costs. Empty buildings, feedlots, unused machinery could all become cash generators rather than just costs.

During the 1980’s farm crisis, many looked to off-farm income as a way to bring income to the household. Off-farm jobs may be an option for the short-run. Careful consideration though must be made whether a job may negatively impact farm income.

The second area of financial management is to review liabilities and make needed changes. The strategies for managing liabilities for managing liabilities include:
• Extend loan terms
• Re-negotiate carry-over operating loan
• Pay interest only on loans
• Reduce debt
• Refinance
• Increase collateral
• Obtain loan guarantees
These strategies can reduce cash outflows during times of financial stress. But if the strategies become a regular feature of a farm and ranch’s management, more analysis and scrutiny of implementation should be done to ensure the desired outcome is occurring.

Assets are the final area to look to for financial breathing room. Use cash to reduce debt where possible and prudent. Sell inventories to pay down debt but assess the tax consequences of the sale to be certain to keep enough cash to pay any taxes due. Lastly, selling capital assets may be necessary if cash must be raised. Again there may be a tax bill due to the sale. The sale of land should be the last of any asset sold for cash.

Conclusion

Early detection of financial stress allows farm and ranch managers time to make adjustments before the situation is too serious to correct. Putting off correction or negotiation only delays the situation and sometimes makes the outcome more severe. So use this phrase when dealing with any problem: “early recognition, early resolution.”

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