Carefully Evaluate Firms before Entering into Deferred Price Contracts

ISU Extension and Outreach pub provides tools for examining financial position of partners

AMES, Iowa – There are many different types of contracts that can be used to sell grain. One of these is a deferred price contract, also known as a credit sale contract. These contracts are different from cash and priced forward contracts because they create a unique relationship between the two parties: the seller becomes an unsecured creditor of the buyer.grain storage elevators

“Deferred price contracts are marketing tools that producers have available to them, but there are risks that need to be understood,” said Keri Jacobs, assistant professor and extension economist with Iowa State University. “With these contract types there may be a delivery component or price component that is left open. Because ownership of the grain might be assigned to a company but the price and payment for it comes later, the credit-worthiness of the company you are doing business with needs to be established.”

Because of the additional risk to the seller, those thinking of using deferred price contracts should carefully evaluate the financial position of firms they are thinking of entering into an agreement with. The type of information sellers should be looking for is highlighted in Jacobs’ new ISU Extension and Outreach publication, “Evaluating a Company’s Financial Position before Selling Grain on Deferred Price Contracts” (FMR 1893).

“Typically there are a lot of questions about pricing components and price risk of this type of contract, but not about the credit risk,” Jacobs said. “If a producer sells grain on this type of contract they become an unsecured creditor. If the company they sold to goes bankrupt or cannot pay, the producer no longer controls the grain and may be last in line for settlement, behind secured creditors such as banks. This publication aims to help producers understand that part of their responsibility before entering into this type of contract is to make sure the firm they do business with is financially secure.”

There are several key financial indicators to think about when evaluating a company’s financial position. These include their working capital, ratio of working capital to sales, leverage, ratio of term debt to net fixed assets and their profits.

“Liquidity is probably the most important factor when trying to understand the short-term financial stability of a company,” Jacobs said. “Their working capital provides the most information about short term cash, inventory levels and what liabilities are against them. Can their current debts be met with their available liquid assets?”

Each indicator is examined, using examples and sample balance and statement sheets to help demonstrate how to evaluate a company’s financial position.

A farmer can more confidently enter into a deferred price contract when they are satisfied with the financial position of the company they are selling to.

This publication was peer-reviewed by two independent reviewers using a double-blind process.