Midwest AGNet - Your Source for Everything AGBecome pro-active in managing farm financial risk

(http://www.farmgate.illinois.edu/) -Literally and figuratively, risk is a four letter word. Some farmers know how to deal with it, others don't do well at managing it, but risk is reality, and there is plenty of it to go around in the world of agriculture. Lately, risk has taken the form of commodity market volatility, farm input price volatility, and a wide variety of other challenges that impact farm profitability. The first step in addressing risk is determining how you are financial impacted by it.

Commodity buyers pass risk down to the farmer. Input suppliers pass risk down to the farmer. And risk is where the buck stops, right at the farm gate. University of Nebraska Farm Management Specialist Doug Jose says some of the old tools to manage risk just don't work anymore and in the recent issue of Cornhusker Economics he suggests that agricultural managers find a way to position themselves for the new year by focusing on working capital, building business relationships, and tax planning.

The issue of working capital is one of the basic elements of farm financial analysis and helps determine the financial viability of an enterprise. Jose says many operations lack liquidity and have to sell assets to gain some degree of solvency. He says the current financial climate has declared that "cash is king," and that tells a farmer to measure his working capital. That is the difference between current assets and current liabilities and needs to be related to the cash needs of the business. Jose says if gross farm income is $400,000, then $100,000 of working capital is sufficient, but not sufficient if gross farm income is $800,000. He says some financial consultants prefer to relate working capital to operating expenses and recommend the ratio of working capital to operating expenses be 50%. Jose says if you have too much, your cash is not working hard enough, but if you have too little, there is not an adequate buffer against risk.

Another way to manage risk is enhancing business relationships, which can mutually benefit both parties, and reduce counterparty risk which has become a serious issue. Jose says that occurs when negotiated transactions are not completed and can occur when one entity goes out of business. He also points to fertilizer purchases and says there is counterparty risk to both the farmer and the supplier if the planned purchase falls through for whatever reason. The development of good business relationships may involve the sharing of confidential information with each other, so both entities are fully aware of what is at stake and making a commitment to follow through so both will benefit.

Jose also recommends a thorough process of estate and tax planning, particularly since many farms had record net income over the past two years, but also for livestock operations that have serious financial issues to manage. He says if profits are available, it is a good time to actively invest those for retirement. He urges farmers to investigate the change of traditional IRAs to Roth IRA and check with a tax planner or farm accountant for guidance. He says livestock producers who are projecting low net farm income and have traditional IRAs may be eligible for a tax break.

Summary:
Financial challenges to all of agriculture can become multiplied if crop and livestock operators do not have a good handle on their financial position. Numerous resources are available to serve as yardsticks for measuring financial performance. Working capital is one of those that will help a manager determine if is money is working hard or is insufficient to serve as a buffer against more risk. Additionally the development of business relationships will help parties understand the challenges of the other and the result of failed business transactions. Tax planning is also a key tool to financially manage a farming operation in times of high financial risk.