While producers are planning their 2017 crops, purchasing inputs and preparing equipment with the inherent optimism a new growing season brings, they’re also feeling the pinch from lower commodity prices and looking for ways to succeed, or at least survive, in the coming marketing year.
During this preseason prep, take some advice from three top farm financial experts—Kevin Gabbert, vice president of commercial lending, FCS Financial; Danny Klinefelter, Extension economist, Texas A&M University; and Raymond Massey, Extension economist, University of Missouri—who offer practical, real-world guidance based on what they’re hearing in the field. All three meet with farmers and farm bankers regularly, positioning them to provide sound business strategies for the challenging times ahead.
Lower your costs—including living expenses.
Massey: The Kansas City Federal Reserve recently asked bankers in our region how much their farm borrowers have increased or decreased capital and household spending. The survey reveals that farmers have cut farm capital expenditures substantially, but lowered household expenses by a much smaller percentage. For example, you might have a tough time telling your college-bound child that while older siblings were given a new car, the younger student will drive an older model. My advice: Get buy-in from your family on the need to reduce household spending.
Gabbert: During the prosperity of the recent past, some producers built a cost structure that may not be sustainable in a lower-margin environment. These overhead costs fall into three categories: land, equipment and labor. You can adjust land costs by reducing rents or stretching out amortizations on real estate notes. You can renegotiate equipment loan terms and liquidate nonessential equipment. Labor costs, including family living draws, have increased significantly in some operations; adjustments in this area can be challenging but necessary.
Sell when you can at least break even.
Massey: A lot of farmers failed to lock in prices when corn hit $4.50 a bushel last year. They wanted $6 like they got a few years ago and were disappointed when corn fell to $3 in the fall. In the coming year, lock in when the market reaches a price that covers your costs.
Gabbert: As margins are squeezed, marketing discipline becomes essential. Know your cost of production and pull the trigger when the market offers a profit. Price rallies in recent years have been short lived, making a defined marketing plan more critical than ever.
Build working capital.
Gabbert: Working capital is king. It provides the first line of defense against low profit margins and positions you to take advantage of marketplace opportunities. Ideally, you should build working capital through retained earnings, but you can enhance it by restructuring debt to longer terms or selling nonessential assets. In this environment, it is critical to weigh the risk/reward of any decision that draws down working capital.
Massey: Agricultural lenders tell me that some of their customers are running out of operating capital and lines of credit. Many are restructuring loans. Don’t wait until you run out of options—talk to your lender now.
Massey: We are seeing a visible decrease in land rental rates. Bankers are suggesting that borrowers renegotiate rental prices to reduce operating costs. Farmers are talking to their landlords, and some landowners are reducing rents by $25 to $50 an acre—in a few cases up to $75. On the other hand, a number of landlords are putting their land out to bid rather than lowering rents. For the working farmer, losing rented land can hurt if you’ve been spreading equipment costs over 2,000 acres, and you can now only spread it over 1,800. But if you can’t make a profit, you’re better off letting it go.
Massey: Most farmers who rent land need to step up their communication with landlords. The farmers most likely to negotiate cash leases downward communicate with landlords on an ongoing basis. Provide regular financial reports to landlords throughout the year—not just when it’s time to negotiate the annual lease.
Gabbert: During adversity, there is a tendency to keep to oneself. But it’s now critical to communicate more frequently with key associates, including business partners, lenders and accountants. This applies to spouses, family members and partners as well. Too often, without good communication, negative assumptions fill the empty space. Financial stress often magnifies interpersonal relationship issues. Broken relationships can be devastating on a personal as well as a business level.
Boost your financial management capacity.
Gabbert: Financial management takes on more importance during times of economic stress. Regardless of your operation’s size, most farmers need more detailed and timely financial reporting to make good management and marketing decisions. The information will also improve communication with business partners, lenders, marketing advisors and accountants. Invest in resources to enhance your financial reporting. Purchase more robust off-the-shelf accounting systems, or ask your accountant for help beyond tax preparation.
Use accrual accounting.
Klinefelter: Every farmer should evaluate his or her business performance using an accrual-adjusted income statement. All it takes is a balance sheet for the beginning and end of the income period you’re evaluating and a cash basis income statement for the period between the balance sheet dates. Then it’s just a matter of making some adjustments to the cash basis income using changes in accrual assets and liabilities from the current section of the balance sheets. Most extension services and the risk management online library at the University of Minnesota have publications that guide you through the process. Cash basis income, while good for tax purposes, can lag behind accrual-adjusted income by two to three years in recognizing downturns or upturns in a business’s true profitability.
Don’t count on last year’s yields.
Massey: In 2016, farmers in Missouri and throughout the U.S. achieved the highest-ever yields for soybeans and the second-highest for corn. Don’t plan on this yield level for your 2017 crop. Base your forecast on average yields over the past five years.
Share costs and pool resources.
Klinefelter: To lower costs, consider joint business arrangements such as pooled input buying or shared machinery. Arrange with several farms to employ accounting or risk management personnel with a higher skill set at a much lower cost per farm. A good accountant can dig deeper than the typical bookkeeper. They can obtain real cost and return data on different enterprises and farms to learn which rental properties are making money and which aren’t. They can also find which zones perform better. Combining this information with soil data, application and seeding rates, you can use variable-rate technology to improve profitability. Too often, aggregated data on the whole operation just provide averages, which don’t differentiate between winners and losers.
Join forces with another operation.
Klinefelter: If your farm is in serious financial difficulty, consider merging with top operations that are looking for additional land and good employees. This helps you preserve what you have left in exchange for a minority interest in a larger operation. It can also preserve jobs for you and your family members. You can trade small or obsolete equipment for upgraded equipment and lease it back to the new entity to avoid the tax consequences of selling. Or, if you operate a traditional small farm with high costs and less up-to-date technology, collaborate with other small farmers. You’ll gain economies of scale while maintaining individual land ownership. Your operations could grow stronger as you better utilize different talents. This new, larger operation can afford to hire more specialized expertise. These arrangements can also be good for a farmer nearing retirement who wants to cut back and get to know potential tenants for when he finally retires. In addition, this approach helps assure the continuation of traditional-sized operators.
Add a second shift.
Klinefelter: Consider double-shifting equipment and labor to improve efficiency and lower overhead during busy seasons. Recruit retired farmers who want to work part time or young people who grew up on a farm but now work an off-farm job. The extra work can help them pay for a new vehicle, Christmas gifts, vacations or credit card debt.
Try something new.
Klinefelter: Do you have tillable land where you haven’t applied chemicals in the last few years because it’s been in pasture? Think outside the box, and try something new such as organic or specialty crops. These can often garner a premium price in the market as as compared to traditional commodity crops.
Limit your risk exposure.
Gabbert: As profit margins are squeezed, the entire industry feels the impact. Be aware of counterparty risk—the risk that the person or institution with whom you’ve entered a financial contract will default on the obligation. Limit your exposure to any one party at a level that your business could sustain the loss if that party does not perform according to your contract.