Do You Know Your Costs

Farm and Ranch income continues to be a concern for many involved in agriculture. Some indicators I have observed include recently closed machinery dealer locations, landowner concerns for rental rates and land taxes as well as 2017 crop production costs projections. The last, estimated crop production costs, are not your costs. The same is true of cow-calf costs as well. To improve cost control, farmers and ranchers must know what it costs to produce calves or grains. Another very important use of cost of production calculation is to manage crop and livestock marketing. UNL has both crop and beef production budgets which users can download. These are located at:

http://cropwatch.unl.edu/budgets

http://agecon.unl.edu/publications/cattle-budgets

One way to use these budgets is to calculate two cost of production, full and cash flow. A cash flow cost of production (COP) is useful when planning or marketing crops. For instance, what if a local grain buyer offered a minimum price contract for corn at $2.99 per bushel. Is that a price a farmer can live with? If the cash Flow COP is calculated to be $2.45/bushel, the producer knows that with the $2.99 minimum price he or she will be able to pay the bills and then some. But if the cash flow COP is $3.07/bushel some costs need to be cut or higher yields obtained at the same total cost. Or maybe both. A cash flow COP production includes all of the out of pocket production costs, the portion of family living the farm or ranch must pay, scheduled debt payments and all taxes.

Full cost of production is also an important cost to know. In the long run, say more than 5 years, all costs must be recaptured to stay in business. These costs include all cash costs plus investment in machinery, land, breeding livestock and unpaid labor. The UNL crop and beef systems budgets calculate both of these costs. Use these budgets to manage your own operation.

Federal Reserve Releases Ag Economy Observations

18 January the Federal reserve released its January 2017 Beige Book which included commentary on current US agricultural industry conditions. Each Federal Reserve district included comments about their district’s ag industry. Some of those comments are below.

Conditions were reported as somewhat variable in the Richmond district depending on whether hurricane Matthew hit farming areas. Conditions across the southeastern US were difficult in many areas due to a growing season drought. Poor pasture conditions caused stress for livestock producers. Some were feeding corn that might otherwise be sold. Rains did occur that brought relief late last year for the southeastern US. The Chicago district reported very good yields and some modest decline in input costs. The livestock sector saw increased prices. Much the same was reported in the Kansas City district as well as Minneapolis. These districts reported “weaker loan repayment rates than in prior years”. Cash flow is reported to be tighter and income lower is compared to prior years. Winter wheat plantings were reported to be 95% complete but little snow was present as of 1 Jan 17 for insulation of the crop. Record yields were reported in the Dallas district. Cotton yields were very good which pushed prices below or near breakeven. But cotton economics are better than wheat economics. In the San Francisco district, dairy economics have improved but investment in dairy is weak due to CA milk prices versus the Midwest milk prices.

More comments can be read from the news report below.

https://farmpolicynews.illinois.edu/2017/01/federal-reserve-observations-ag-economy-january-17/

Cash Flow Planning for 2017

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Planning is a common activity for farm and ranch managers and operators. It includes crop rotations, when to wean, when to sell crops or calves and when to take an LDP. All of those activities inevitably lead to cash and income. “Cash Flow Statements”can be used to plan an agricultural business’ need for borrowing, when to make payments for various expenses or when to make crop and calf sales.

A statement of cash flows summarizes cash inflows and outflows for a specific time period. It can be used to project, pro forma, future cash flows or to summarize past cash flows. Cash inflows include product sales or sales of capital items but also borrowing and investing. Cash outflows include loan payments, supplier payments, machinery lease payments, land rent payments, taxes and family living draw. The size of all these matter but so do the timing of the cash flows. A proforma cash flow statement allows the farm and ranch manager to set up lines of credit, plan crop sales, plan vacations, project tax payments and even which crops to plant. The statement of cash flows is usually done either quarterly or monthly.

Proforma cash flows can be prepared either by:

  1. use last years actual cash flows to project the coming year’s cash flows.
  2. project the coming year’s cash flows from each farm enterprise with details about probable prices, yields, expenses, family living draw, property taxes, income and social security taxes.

The first method is quicker but unless it is adjusted for crop price and yield variation, changes in input costs, changes to debt servicing, likely changes to tax liability and changes to family living it may be too far off the mark. Many farmers already calculate costs and returns for their crops or calves. These are called enterprise budgets and can be used to build a cash flow using the second method. This second method also allows the user to mix enterprises as needed to increase profitability and increase positive cash flow.

Many tools are available to help with cash flow development. Nebraska Extension will soon publish the “2017 Crop Budgets” at http://cropwatch.unl.edu/budgets. Right now the 2016 budgets are up. Iowa State University Extension has an article further explaining cash flow budgeting and two Excel spreadsheets to help with the process at http://www.extension.iastate.edu/agdm/wholefarm/html/c3-14.html. Oklahoma State University has a paper form for cash flow budgeting, http://agecon.okstate.edu/annie/files/F-751%20Cash%20Flow.pdf. The University of Minnesota has an online workshop about cash flow at http://ifsam.cffm.umn.edu/StatementCashFlows/Default.aspx?SectionID=5 to help you further understand cash flow planning. Nebraska Extension also has a web video that helps explain Cash Flow Planning at https://vimeo.com/188871642.

 

Communicating with Lenders: Suggestions for Farmers & Ranchers

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The last few years have been tough for many farmers, feeders and ranchers due to a cost-price squeeze. I reviewed the 2015 Nebraska Farm Business INC financial standards measures. Average 2015 Net Farm Income was $51,293 which doesn’t sound terrible until you get deeper into the numbers. The farms are broken into 10 equal groups, deciles, ranked by Net Farm Income. The bottom four deciles of farms were unprofitable with the lowest decile averaging -$109,508 net farm income. At the beginning of 2016, the bottom three deciles had negative working capital with the lowest decile averaging -$244,880. The numbers above and the current cost-price squeeze will probably worsen the financial position of additional farms and ranches. Fortunately equity has increased for many farms and ranches and that can be used to shore up current lending needs. Communicating with lenders  will be an important activity over the next months. Here are suggestions for that conversation’s success.

  • Always be upfront about the exact situation, sooner rather than later. Be frank about what your financials are but don’t talk with the lender constantly.
  • Make sure that all your financial documents are accurate. Include all machinery leases or outside lending listed on the correct financial documents. Consider producing a farm and personal balance sheet including credit cards on the balance sheet.
  • Do your own cash flow projections for 2017 now. A cash flow projections allows you to discuss your needs with your lender. The process of making a cash flow projection can be very illuminating to operators. The cash flow projection can guide marketing plans as well. Update the cash flow periodically during the growing season and share the update with your lender.
  • Explore marketing plans, write one and implement it. Again marketing plans should be flexible as new information comes forward. Again share your marketing plan with your lender.

The foregoing suggestions show a borrower that is proactive and forward-looking which is a very positive asset that lenders want to see. Be proactive!

Refinancing the Farm or Ranch

Situation

One of the concerns that has become obvious to many in agriculture is the rapid reduction in working capital the past few months. Operating loans for 2016 may not be paid off after harvest, especially with the rapid decline in grain prices since mid-June 2016. Refinancing or rolling forward the remainder of the operating loan is going to be an option for many farms and ranches. A lender may ask for more collateral to do the roll however or indicate there is enough to cover the additional debt. But rolling operating notes forward is a warning sign for farm and ranch operators. Why?

The incomplete payment of a current operating loan reflects a problem that farmers have experienced during the current growing season, a severe cost price squeeze. Simply rolling the debt to the next year and collateralizing it with machinery or land or cattle does not address the underlying cause. Not addressing the problem can lead to future outstanding operating loans and more debt to carry in the future. The remedy is to address the current cash flow problem.

Cash Flow Shortfall Solutions

There appears to be three cost areas that farmers and ranchers must address. Cash Rent rates are the first to deal with as these are being determined at this time. At least for the medium term, grain prices are not going to increase significantly above current numbers unless some dramatic occurrence takes place, e.g. a drought or a war. So cash rental rates need to match the income reality of the next few years.

Family living draw has increased in farm country since the ethanol boom began in 2006. In Nebraska, farm family living draw, not including taxes, doubled from 2004 to 2013 which was its peak. Since than in each of 2014 and 2015 family living draw declined by 4%. Some family living costs have increased since than which are hard to reduce such as health care and insurance and college costs. But family living will need to decline or added debt will be incurred without additional income.

Crop input costs must also be considered as well. This is the season when suppliers begin to offer pre-payment and booking incentives. How much have those prices declined since last year? Reports I have gathered indicate not much certainly compared to income from corn and soybeans. Farmers will need to indicate to suppliers their unwillingness to pay those prices before input prices are likely to drop. Don’t let emotion drive your input decision either. Products are available claiming better control or availability of an input. Farmers and ranchers should request unbiased research that shows a positive cost-benefit to the use of any input. With that research, they can analyze whether to use and how much of a product to use. Testimonials are not useful to make that cost-benefit analysis.

And then income can also be managed. Have a marketing plan and implement that plan. Of course farmers should not follow it blindly if some new information comes out which changes supply–demand of grains. At that point adjust the marketing plan. Robert Wisner, retired Iowa State University grains economist, related some of his research from more than a decade ago which showed that US corn farmers sold two-thirds of corn at a price less than the marketing year average price. Michael Swanson, Wells Fargo Chief Agricultural Economist, made the same point recently. Minnesota farmers sold the 2015 corn crop 6 cents per bushels less than the Minnesota average corn price. Most likely emotion drove farmers to wait for higher prices and eventually sell at below average prices. Following a marketing plan removes some of the emotion and can lead to more predictable income.

Summary

A proactive approach to managing the current cost-price squeeze dilemma is the way forward to improve sustainability. Farm and ranch managers have some control of the costs and income they can expect from their farm or ranch. Careful cost control, using marginal analysis, in all areas of production must be implemented first to improve cash flow. Marketing plans can have the effect of removing emotion from the selling decision and thus avoiding poor decision-making. Farms and ranches with high leverage are most at risk in the next few years and will need careful management to pull through. After those strategies are implemented, rolling current operating loans forward has a much better chance of being successful.

References:

Schnitkey, G. “The Danger of Refinancing.” farmdoc daily (6):164, Department of Agricultural and Consumer Economics, University of Illinois at Urbana-Champaign, August 30, 2016.

Swanson, M. “ True Farmers Never Sell a Rally.” https://wholesale.wf.com/food_for_thought/true-farmers-never-sell-a-rally/?contact-type=e&elqTrackId=dcac80eb4e684bc8977eb3b76e2bddad&elq=86e73390d8bc4e2d8c04ac217725a456&elqaid=9465&elqat=1&elqCampaignId=6120, Accessed 1 Sept 2016.

Wow What a WASDE!

The last few days have had the WASDE August 16 report released and a few days later I attended the Midwest-Great Plains Ag Outlook /conference in Des Moines IA. Many of us have heard the headlines from the WASDE report predicting the US largest corn and soybean crop on record. US corn yields are projected at 175.1 bushels (BU)/acre (A) for a 15.153 billion (b) bu crop. Both the size and yield were higher than the highest trade estimate. The same happened with the soybean estimates in WASDE, 4.060 bbu with 48.9 bu/A. Both are higher than trade estimates like the corn trade. Sounding like a broken record, milo followed the same pattern with WASDE beating trade estimates projecting 0.475 bbu total with 66.2 bu/A, both higher than analyst estimates.

Last year’s crops were not the largest on record leading to slightly lower corn ending stocks however soybean ending stocks did rise. Ending stocks for both corn and soybeans are projected to increase after the 2016 crop is harvested. Corn ending stocks are projected to be over 16% and soybean stocks 8% of use. That compares to last year’s ending stocks of 12% for corn and 6.5% for soybeans. The expected increase will over hang corn and soybean prices for some time, until some kind of news, lower yields or higher exports or problems with other country’s grain production, would change the supply/demand calculation. At this point however there are no big news items that could change our grains market to one that is bullish.

So what was the consensus, as if there really is such a thing, or my perception of it, at the Midwest-Great Plains Outlook conference? Except for a few areas of crop problems in Ohio and Michigan, crops are in very good shape and are likely to perform very close to the high yields that USDA and other crop yield modelers have calculated. No significant disease or insect problems were reported. The discussion led eventually to marketing, storage and transportation of the Fall 16 crop. We already know some portion of the winter wheat crop is stored on the ground which will likely lead to loss of quality and quantity. That wheat will probably end up in feed. The US wheat stocks are projected to be 47% of use by crop marketing end while world wheat stocks are projected to be only 35% of use. That is some good news for wheat but stocks of world wheat are up even though use is projected to be up. Use is projected up for the US wheat crop and still stocks are projected to increase. The same situation is going on in corn and soybeans. So then another question is about transportation. Railroad companies are telling university crop economists that they are ready for the anticipated large fall crop. Coal shipments are lower than in previous years freeing up rolling stock to move grain more expeditiously in the past. That is good news for farmers who can anticipate that Fall 16 basis may not be as low as would have been.

What are farmers to do when marketing such a big crop? Many will be convinced to store rather than sell at or near harvest. Big crops tend to have poor carry and thus storage may not gain enough to pay for itself. In planning post harvest crop marketing, farmers must consider the carry that is offered. If the carry is less than the cost of storage, the market is telling you to sell sooner rather than later which would mean less money for the crop in the future due to storage costs.

What Are Lenders Thinking About the US Ag Economy?

The US agricultural economy has had a tough ride in 2015. Recently the Kansas City Federal Reserve (KCFR) reported the 2015 Net Farm Income (NFI) Index at 55 (2004=100) and the operating loan index at 150 (2004=100). The NFI index is at its lowest and the operating index at its highest since 2004. Those data points reflect ongoing KCFR declining credit conditions. (Figure 1)

Figure 1

10 dist conditions

Source: Kauffman, KCFR

You will notice that the district agriculture loan repayment rate has been trending down since 2012 while loan renewals and extensions have been trending up. Farm loan demand is obviously up as well. KCFR found short term 1st Q 2016 short term lending 20% higher than historical expectations would lead one to believe. District ag lenders expect some deterioration of those credit conditions. The current credit conditions are related to profitability which the KCFR summarized in their findings. KCFR found that lenders believe:

  1. Due to strong US and world production and relatively high production costs and weaker world demand, NFI will continue to be weak.
  2. Tightening credit conditions will effect lending to farmers and ranchers.
  3. Downward pressure on cash rents and farmland values will continue due to weaker NFI.
  4. The broad US rural economy will weaken.
  5. For farmers and ranchers who have a strong financial position there will be opportunities to gain control over additional land and cattle.

One ag economist, Greg Ibendahl Kansas State University, suggests that loan delinquency rates are a trailing indicator for financial strength because it takes a couple of years for them to develop. A better indicator then would be working capital and NFI. Farmers will often use their working capital to pay down debt early on but if NFI drops too, working capital won’t get rebuilt. After working capital drops off farmers will sell off assets like extra machinery to generate cash for debt repayment or reduction. Eventually if NFI can’t be increased and or expenses reduced, the debt delinquency rates will increase.

Rabobank serves the US agriculture industry as well as various EU and Asian clients. Thus their analyses often include a world perspective also. Periodically they review the ag complex. Their most recent analysis covered the corn and protein complexes. In early April fed cattle prices were thought by Rabobank to have trouble reaching $140 per cwt. and that has turned out to be correct with nearby CME fed cattle near $120 falling from $130 in mid-March. Feeder calf prices have weakened since their April analysis was published. Rabobank mentions that very heavy carcasses continue in the beef industry and are a drag on prices since they increase beef supply with the same cattle numbers. Sterling Marketing’s Beef Profit Tracker” continues to show beef feeders losing money as of 29 April, -$74.64, and their analysis going back 1 year shows losses as well. Under that scenario feeder calf prices will decline further, but feeder calf supplies are lower than usual due to the recent drought in cattle producing areas.