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October 21, 2020

Farm Budgeting and Risk Management

Farming is an industry of abundant reward yet frequent risks.

The unpredictability of the agricultural industry combined with its essentiality makes it both volatile and steady in nature. Farmers have the freedom to be their own boss, are an integral part of society, and can rest assured knowing that their work will always be needed. However, with this freedom and sense of purpose come unforeseen roadblocks—many of which are outside a farmer’s control.

Farmers and ranchers may not be able to control things such as destructive weather, trade tariffs, or fluctuating market prices, but they can implement strategies to cushion the blow from unpredictable obstacles when they arise. If 2020 has taught us anything, it’s that risk management in agribusiness has never been more imperative than it is now.

Keep reading to learn more about how to effectively analyze farm profit margins and implement risk mitigation strategies to keep your agricultural operation strong through economic strife.

Financial Documentation to Consider When Analyzing Your Farm Budget

Farm risk management begins with knowing the data behind your operation year-over-year. Becoming accustomed to crunching, updating, and analyzing the numbers will allow you to make smart financial decisions and see what areas hold space for improvement. Three types of farm profit documentation most beneficial to agricultural operations are profit and loss accounts, balance sheets, and cash flow statements.

Profit and Loss

Profit and loss accounts represent recorded documentation of income and expenses that occurred—whether it’s quarterly or annually—and shows the cash available to purchase assets, reduce debt, and pay income taxes. Profit and loss evaluations are typically conducted at least once a year and provide insights on return on investments (ROIs) of operational costs along with the growth or decline of trading profit margins for each cycle. It’s helpful to separate profit and loss accounts by crop type and land parcel as well in order to better track the best areas to scale or pull back.

Balance Sheet

A farm balance sheet lists operational assets, liabilities, and current net worth. Intervals typically range from monthly to annually; however, staying on top of your agribusiness balance sheet information consistently will make it less of a monumental project and more of a quick task. While each operation varies in optimal time to complete balance sheet information, farmers and ranchers often prepare this documentation around the time when harvests are sold and inventory is low. Whatever you decide, be sure to do so at a consistent time each year to ensure information is as accurate as possible for future comparative analysis.

Statement of Cash Flows

A Statement of Cash Flows provides transparency into the source of your agribusiness funds and how these funds are being spent. Sources include direct farm income, ad hoc payments, savings account, lines of credit, off-farm income, and more. Disposals—or rather where your money is spent—includes input costs, farm labor, land purchases, loan payments, and equipment investments. Consistent cash flow documentation is imperative in understanding the farm profit margins needed for long-term success and the development of quantitative goals for your operation. While profit/loss accounts and balance sheets are required documents for third party reporting, cash flow statements are a valuable internal tool to ensure liquidity needs are being met within your operation.

Risk Management Strategies in an Unpredictable Industry

Once you have a firm grasp on the break-even point and profit margins needed to keep your operation sustained, it is time to implement strategies to protect its financial health by preparing for financially lean seasons. Below are several of the most common risk management strategies used by farmers and ranchers.

Market Intelligence

If the definition of market intelligence could be condensed into three words, it would be: know your why. Articulating your distinct financial and operational goals clearly and concisely is the first step in achieving them. A successful agribusiness begins with understanding market trends within the industry and, more importantly, having a firm grasp on your personal measurement of success. Ask yourself:

  • What are my financial goals?
  • What are my input costs?
  • What is my break-even price?
  • What would I consider to be an acceptable profit for my operation?

Quantifying your goals makes it easier to assess the steps that are needed to accomplish them in times of crisis.

Hedging and Diversification

In financial portfolio management, hedging and diversification are two strategies used to smooth the risk of particular investment ventures. Although similar, hedging involves taking an opposing position in a related asset to offset potential loss. Diversification involved mixing a wide variety of investment types within a portfolio. Bringing this strategy into the world of agriculture involves expanding commodity production and investing in hedgers against potential disasters, such as crop insurance. Hedging and diversification of agricultural assets such as crop type and land can yield higher long-term returns and lower the risk of an individual commodity.

Forward Contracting

One of the most common hedging practices farmers and ranchers implement is the process of forward contracting which locks in price and buyer commitments prior to harvesting. According to a recently released USDA report, an estimated 10 percent of corn and soybean farmers traded in futures contracts in 2016. Those who implemented forward contracting covered more than 40 percent of total production on average. Seven percent secured their total production through forward contracting. This risk mitigation strategy establishes a return, minimizes crop waste, and buffers against potential price volatility.

Value Tracking

Of all risk management strategies in agriculture, accurate value tracking is arguably the most important. Value trackers are indicators that monitor and evaluate the financial health of an operation. Value tracking—also called monitoring and evaluation (M&E)—involves collecting data related to input costs, liabilities, assets, and more. Through this data collection, farmers can make smart decisions regarding their operation. Just as discussed earlier in regards to the cash flow statements, tracking values related to land parcel and commodities help you monitor the input costs and ROIs of both land and crops. An effective value tracking system highlights weaknesses and strengths within an operation’s financial structure, equips farmers to make data-driven decisions with confidence, and makes securing financing through a lender or federal incentive program more accessible.

Supporting the Future of American Family Farms

With a singular focus on agricultural land lending, AgAmerica’s resources are concentrated on the creation and continued innovation of loan products specific to rural land financing that provide a buffer against unexpected risks that come with the industry.

Through revolutionary thinking and a dedication to the legacy of American agriculture, we stay committed to providing our nation’s farmers, ranchers, and rural landowners with modern solutions to traditional financing. Our resilient financial restructures allow our clients to thrive in good times and rest well during the tough ones.

Learn more about the flexible financing options available to you by speaking to one of our land lending experts.

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