Story by John LaPorte and Mark Longstroth, MSU Extension
After struggling through the 2019 season, the agriculture community is looking to reset in 2020. Until the arrival of snow in mid-April, the weather was cooperating. There were opportunities to get into fields and operations appeared to be ahead of last year. Even with improved weather, commodity prices are challenging. Global and domestic demand has collapsed, pushing prices below 2019 levels. Many producers are wondering about their farm’s ability to handle another year of low profits.
Financial risk and farm profitability
Handling low profits means you need to manage the financial risks affecting your operation. These types of risks focus beyond production or marketing risks, such as poor weather or low market prices. Financial risks include increased input costs, high levels of loan debt, low working capital, and or poor or incomplete budgeting for yearly needs. When these risks are present, there is often insufficient cash to pay bills, lower than anticipated profits, and potential loss of owner equity. Farms that manage these risks are considered highly resilient.
When thinking about your farm’s profitability, consider whether your operation is financially resilient. How well can your farm absorb or withstand unexpected changes and potential financial risks? Do you have the ability to recover from these types of risks or adapt to change? How can you build and utilize your farm’s resilience when low profits are expected?
Building financial resilience starts with understanding your farm’s capacities and liabilities. This includes your level of working capital, existing debt, and operating efficiencies. Knowing your capabilities helps determine what options or opportunities are available to you. Equipped with this knowledge, you can make decisions that yield the best outcome for your business.
Conduct your own financial analysis
Start by analyzing your previous production year. Adjusting cash transactions by accounting for prepaid purchases, crop or livestock inventory changes from the beginning and end of the year, depreciation, loan balances, and any unpaid bills reveals your actual revenues and costs. This analysis outlines your farm’s financial situation and capacities right now. It provides you with a picture of your actual profitability for the past year.
Project your cost of production
This financial analysis also enables you to look deeper at each individual commodity and determine what it actually costs you to raise them. Knowing last year’s cost of production can help you more accurately project this year’s cost of production. What costs will be the same or have changed because of input prices or changes on the farm? You should also consider any changes to production practices and their impacts to your overall costs. There are several tools available to assist producers in identifying their cost of production on the Michigan State University Extension Farm Management website.
Manage your costs
Once you can project this year’s cost of production, you have a better understanding of your farm’s potential profitability. Now you can think about how to manage it. Should your crop rotation be adjusted to more acres of one crop or another? Are there costs that can be changed or managed more closely? Many costs are set – what costs remain that you can impact? Do not forget smaller costs: added together, they can cost just as much as larger items.
Rent is one area that needs to be a common talking point for farmers and managers. It is one of the largest costs and can mean a lot to your farm’s profitability. If a 200 bushels per acre corn farm lowered its rent by $50 per acre – that is the same as the price increasing 25 cents per bushel. With a 60-bushel soybean yield, that would be an 83 cents per bushel increase in price. Even if rent has been set for the year, it may still be the time to revisit those costs with landowners. Having a conversation about the current struggles in agriculture helps landowners understand the impacts on you and the farm community.
For information and assistance on rent value considerations, visit MSU Extension Farmland Rent Considerations.
Revisit risk management tools
In addition to knowing and managing your cost of production, examine what happens to your cost of production with an increase or decrease in yield and/or price. What risk management tools are you already using, or could you be using to manage this risk? With lower market prices, payments from the U.S. Department of Agriculture’s (USDA) Price Loss Coverage (PLC) or Agriculture Risk Coverage (ARC) may be available; however, this depends on your county and the program you enrolled in. Revenue protection through crop insurance may also assist in deciding how much of your production to forward contract. Depending on market prices and your insurance level, this is another use for your projected cost of production.
For more information on crop insurance options and their potential benefits, visit MSU Extension Farm Management Crop Insurance.
Review debt payments
Another area to look into is how your farm debt is structured. What are the current loan payments you plan on making during, or at the end of the season? How much of your farm profit will be needed to cover these payments? Speak with your creditors sooner, rather than later. This helps identify your options to ease financial burdens from borrowed debt. Look for options that keep profits from leaving your farm and available for your use where it is needed most.
Weather and commodity prices have been challenging in recent years, and the latest market impacts have made many situations more difficult. Understanding your farm’s financial situation provides you with a foundation of knowledge and outlines how resilient your business is to financial risk. It helps you identify your opportunities to reduce costs or capture profits when they are available. Examining your situation provides you the ability to make sound, well-informed decisions to help your farm make it through tough times.