Understanding Financial Risk....

is yet another portion of the Risk Management "pie".

Financial Risk has 3 basic parts:

- the cost and availability of debt capital
- the ability to meet cash flow needs in a timely manner
- the ability to maintain and grow equity

Cash flow is very important because of so many ongoing farm obligations, i.e. cash input costs, cash lease payments, tax payments, debt repayment, and family living expenses. Often, off-farm employment can be a financial risk strategy. It ensures that living costs are met, raises the standard of living and may reduce the need to liquidate farm assets.

Financial risk should be managed through sound planning and financial control. Monitor your ability to bear financial risk continuously.

A set of well-maintained financial records is critical to maintaining financial control of a farm or ranch. This helps in evaluating past performance and planning for the future. Some essential financial documents include the balance sheet and statement of equity, income statement, and project and actual cash flows. As the operation grows, more records will be needed – ratios such as debt-to-asset, debt-to-equity, and asset turnover are important monitoring tools.

There isn’t much anyone can do about interest rate risk; however, by lowering your debt-to-asset ratio and having crop insurance as well as a sound marketing plan, you can sometimes influence your interest rate. Add maintaining accurate financial records and a consistent record of timely repayment of loans and you can expect continued access to debt capital when you need it.

Production Risk

In my previous blog, I mentioned five primary sources of risk I mentioned previously, today I’m going to cover Production Risks. Agricultural production suggests an expected yield or outcome. When variations in those expected outcomes occur your ability to achieve the financial goals you set are at risk.

There are five major sources of production risk: weather, pests, diseases, the interaction of technology with other farm and management characteristics, genetics, machinery efficiency and the quality of inputs. With these in mind, read the strategies listed below and see if any can be implemented for your operation.

Crop insurance is a risk management tool that protects against losses and also offers the opportunity for more consistent gains. It provides two important benefits: ensures a reliable level of cash flow and allows more flexibility in your marketing plans. There are a wide variety of crop insurance programs and coverage levels available. Crop insurance is available on more than 60 crops but must be purchased through a private crop insurance agent. More information regarding crop insurance is available on the ArborOne website.

An effective way to counter income variability is through diversification. The combining of different production processes is diversification. It is effectively implemented when the low income from one enterprise is simultaneously offset by satisfactory or high income from other enterprises. Diversification can be different crop types, combination of crops and livestock, different endpoints in the same production process or different types of the same crop.

Contract production is when an agribusiness firm commits the producer, through a contract, to deliver a specific quality and quantity of final product. Common in poultry and livestock, it is not unheard of for specific row crops such as tobacco or peanuts.

Evaluating new technologies is a valuable practice for today’s farmer. Two of the newest are genetically altered seeds (herbicide, disease and insect resistant) and precision farming (technology that controls the rate of application of crop inputs such as seed, fertilizer and pesticides on each acre of land). Farmers who adopt these innovations are trying to reap the benefits of lower input costs and environmental quality, as well as higher crop yields due to improved pest control and cost effective use of crop inputs.

See anything that interests you? Something that may help? Don’t hesitate to contact the relationship managers at ArborOne Farm Credit. We are the agricultural finance experts. We have answers.
Next time… Marketing Risks

Risk Management

Let’s be frank, the economy hasn’t exactly been stable the last 18 months. Although it is not possible to plan for instability, having a plan in place helps a business prepare for the coming year – stable or not. Risk has always been a part of agriculture, but farming in America has changed dramatically in the last few years. And with these changes, our farmers are looking at new ways to approach Risk Management. There have been many changes in producers’ business environment. Thanks to these changes, there are increased opportunities, but also increased risk.

Some of these risks are:

Changing governmental role – with policy makers placing greater confidence in the ability of producers to make sound business decisions, market-oriented farm legislation and crop insurance reforms have been passed allowing producers to be more active in managing their profit opportunities and risks.

Outside forces – increased global competition, rapid changes in the structure of production agriculture, changes in the marketing of ag products in the farm supply sector, new technology and volatile weather.

Risk connections – decisions in certain risk areas are affecting the riskiness and profitability of other aspects of farming.

An illustration of these risk connections would be lenders requiring a sound business plan before approving credit. Showing the good management of marketing risks can lower borrowing costs and result in long-term financial stability. As farmers note this connection, and others, the need for effective risk management will grow.

There are five primary sources of risk for a farmer: production, marketing, finance, legal and human resources. Each of these five have major sources of risk (i.e. production/weather) and strategies (i.e. crop insurance) that can be considered to lower risks. I encourage you to learn the basics, employ strategies and never hesitate to ask questions. Your ArborOne Relationship Manager, local extension agent or local USDA office is more than willing to help.

Check back. Over the next few days I will outline the five primary sources of risk and the strategies that can be used to counter these risks.