Whole Farm > Cost and Return > Profitability

Financial management with high prices

AgDM Newsletter
May 2011

Rarely do Midwest agricultural producers see above average prices for both grains and livestock at the same time. Even though prices of feed, seed and fertilizer are also at historical highs, many farm families will find themselves with more than the usual amount of cash left over in 2011.

Much has been written about financial management strategies when times are tough. In reality, the most important financial decisions are often made when times aren’t so tough. As one ag lender said, “Most bad loans are made in good times.” So how can farmers position themselves for the inevitable downturn?

Replace assets. Updating the machinery line and replacing equipment now will lower cash flow requirements in the future. It is possible to “live off depreciation” when margins get tighter. But don’t invest in larger machinery unless you really need the extra capacity. And use equity dollars as much as possible.
Expand cautiously. Many farmers want to invest extra cash in land, but when everyone is looking to buy, prices rise rapidly. Buying land with 50 percent or more equity will help ensure that the payments will cash flow even under lower prices. The same holds true for livestock facilities. Highly leveraged expansion projects during high price periods often come on line just in time for lower selling prices. Borrowing to grow the business is acceptable, but keep the ratios in line.

Improve efficiency. Look for ways to invest in cost-saving technology. Innovations like automatic guidance systems and seed shut-offs save money in the long run.  Improved feeding systems can cut waste and lower costs of gain.

Reduce debt. Look for the highest interest rate loans you have, and see if there is any penalty for prepaying principle. Reducing debt provides a guaranteed return on your investment, and leaves equity available for borrowing again in the future.

Fix interest rates. Current interest rates are low by historic standards. The small penalty charged for a fixed rate could look like a bargain in a few years.

Forward price production. Many grain producers who forward priced their products in 2010 felt cheated when prices soared at harvest time. But that was an exceptional year. Tight supplies could possibly lead to even higher prices, but you don’t have to hit a home run if you get enough singles and doubles. Don’t overlook opportunities to forward price livestock, too.¬† Livestock Gross Margin and Livestock Revenue Protection insurance are available for cattle, hogs, lambs and milk at a relative low cost through your crop insurance provider.

Negotiate a flexible lease.  Incorporating both actual yields and prices into a formula used to set the cash rent each year will automatically reduce costs when revenues decline, while fixed cash rents may take several years to react. And the landowner can still benefit from higher returns. Avoid locking in high rents for multiple years unless you can price your product for the same period.

Diversify assets. You don’t have to limit yourself to agriculture. There may be bargains available in nonfarm real estate or retail ventures. Or mutual funds can return a steady income at a level of risk that you are comfortable with.

Consider ACRE (again). Enrollment in the ACRE program was light when it was introduced in 2009.  But ACRE guarantees are based on a two-year moving average of the marketing year price. That two-year average price is projected to be $4.48 for corn and $10.55 for soybeans for 2011 crops. Both could be substantially higher for 2012, however. The cost for signing up is loss of 20 percent of your USDA direct payments through 2012. The enrollment deadline is June 1 this year.

Take a vacation. Long hours and hard work deserve a reward when the income is there.

The farm crisis of the 1980s was hard on all farmers, but those who put their financial houses in order during the years leading up to that period were able to weather the storm successfully.

 

William Edwards, retired economist. Questions?