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5 Strategies for Financial Resiliency
If there’s a pot of gold to be found in narrow to nonexistent profit margins, it could be this: the birth of a resolution to financially insulate your operation against future economic downturns.
“Farmers need to be prepared for times like these,” says Jim Mintert, director of Purdue University’s Center for Commercial Agriculture. “An operation should develop the financial resiliency to handle economic downturns like the one we’re in. That presents a fundamental challenge for farmers who have a cost structure that’s not consistent with the current environment.
“One of the keys to long-run success in a commodity business is pretty straightforward: Be a low-cost producer,” says Mintert. “Many people don’t focus their attention on managing the cost side of their business. Instead, they focus their attention on increasing volume and revenue. Lowering production costs consistently over a long period of time, however, can make a big difference. Significant changes in production costs result from a combination of small changes over time that, when compounded, make a big difference.”
Mintert offers a five-step strategy for using short-term survival tactics to develop long-term financial resiliency.
1. Restructure debt. Restructuring debt is an immediate survival strategy that may cost more over the long term, but it has the advantage, of course, of freeing up cash in the short term.
“Cash provides your first line of defense against financial stress, serving as a buffer,” says Mintert. “Cash provides you with flexibility to pursue unforeseen opportunities that sometimes arise. Having cash on hand helps mitigate risk.
“Now is also the time to restructure debt, because long-term interest rates are still near historic lows,” he continues. “Odds favor interest rates moving higher over the next several years, so locking in current rates makes sense.”
Yet, restructuring debt works best for purchases of real estate and only when your debt-to-asset ratio provides what Mintert calls restructuring capacity.
“One of the advantages of having significant increases in land values over the course of the last seven to 10 years is that the increase in land value has provided a collateral security base to enable lenders to refinance because they may have the security to do it,” he says.
In cases where land has previously already been highly leveraged, restructuring is less likely to be attractive to a lender.
“When refinancing a land purchase, your focus should be on the repayment terms,” says Mintert. “With low interest rates available and continuing prospects for tight operating margins, it makes sense to refinance land purchases for as long as possible – 20 or even 30 years. The lower payments associated with a longer repayment period will make your farm more resilient to stress.”
It goes without saying that operating notes are poor candidates for refinancing, but the same goes for midterm debt incurred for purchasing equipment.
“The value of machinery is declining faster than land values,” says Mintert. “Lenders are typically not happy about using equipment to refinance debt.”
2. Protect working capital. “Working capital is the difference between current assets and current liabilities,” says Mintert. “During the boom times in crop agriculture, many crop farmers drew down their working capital to purchase assets including machinery, buildings, and land. With strong operating margins, farmers were able to rebuild their working capital in the following year. Now that margins have tightened, that approach will not work. If you have already destroyed your working capital position, you need to think strategically about how to rebuild it.”
3. Determine a safe debt load. “In the long run, you should determine what amount of debt is a safe debt load for your business,” he says. “You should consider how you’ve positioned yourself to handle economic downturns. Shock-testing your business on paper will show how vulnerable the business is to either decreased prices or yields.” (See story at right.) Selling assets might be needed in order to reduce debt.
4. Reduce cost of production. “Restructuring debt buys you time to solve the fundamental problem, which is the need to lower costs in order to increase cash reserves and profitability,” says Mintert. “Being a low-cost producer is easier said than done, however, since you may think you are already operating at the lowest possible cost. The first thing to do is to change your mind-set. Every morning, remind yourself that your number one job is to lower your costs. It’s an everyday job.”
Negotiating reduced land rental rates gives a good starting point in cost control. “You might also have to consider giving up some rented land if the rental rate is simply too high,” he says.
Reducing costs for purchased inputs is, of course, another area potentially offering significant cost-cutting leeway.
“Work hard at making smart decisions relating to fertilizer and chemicals so that the cost per bushel is lowered for these inputs,” says Mintert. “Be very cautious about any kind of capital expenditures. You may have to reduce family living withdrawals from the business.”
5. Set operating procedures. Establishing systematic processes and outlining them in a set of standard operating procedures (SOPs) help daily work to stay focused on production goals, including those committed to reducing costs.
“Most successful businesses follow a set of standard operating procedures,” says Mintert. “Following an SOP ensures that the job is done right, and doing the job right helps reduce costs per bushel. An SOP should be robust enough to anticipate changes in conditions and actually encourage your team members to make the right decision for the conditions at hand.
“Following an SOP can make your farm more efficient and timely, and it can help you become a low-cost producer. It can guide your operation out of the red and into the black,” he says.
Stress-Test Your Business Plan
Performing an annual stress test on your business plan can suggest further adjustments yet to be made in your production strategy.
“Do a stress test by figuring some straightforward assumptions about the operating year,” says Purdue University ag economist Jim Mintert. “For instance, take your projected income for the year and figure out what would happen if crop prices were 10% lower. Would your operation still have repayment capacity to service outstanding loans?”
You might work out other what-if scenarios. “If you had yields that dropped 10% or 15%, what would that do to your financial position?” he asks. “These sorts of analyses will show the vulnerabilities in your production plans.”