Use these tips to handle volatility and maximize profit.
Has farming tested your endurance the past few years? "It seems volatility is here to stay, so making plans to successfully manage risk on your farm is vital," says Michael Boehlje, Purdue University agricultural economist. "The greatest risk is not knowing what you’re doing." That’s why he and fellow Purdue economist Brent Gloy offer these recommendations to survive the volatile agricultural environment.
1. Lock in Margins. Farmers are experiencing the highest margins in the past 20 years. "We will not be able to sustain these high levels of margins, though," Boehlje warns. Gloy adds that inputs tend to follow in step with profits, so expect inputs to also increase.
2. Buy Crop Insurance. Crop insurance may be the most obvious strategy to manage risk, Gloy says, because it helps protect yield and price. "The products have changed over the years and have gotten better," he says.
3. Consider Fixing Interest Rates. Interest rates are extremely low right now. Boehlje suggests having a combination of fixed and variable rates to diversify. "Seriously consider what the risk is with your current interest rates," he says. Gloy adds, "Also ask yourself: What’s the risk to my operation if interest rates substantially increase?"
4. Pay Down Risk. Farmers are experiencing earnings and cash flow that are at all-time highs, which give them the opportunity to pay down debt. Boehlje advises farmers to not let this opportunity to lock down interest rates or pay down debt pass by.
5. Hold Financial Reserves. In the financial markets, working capital is the first defense against a crisis, Boehlje says. "Increasing working capital and cash reserves puts you in a stronger position."
6. Conservative Bidding/Buying. Don’t get caught up and lose track of the huge risks associated with high profits. "Be careful making long-term commitments based on short-term margins," Gloy says.
7. Slow Growth/Fund with Equity. Remember that the additional volatility means that businesses cannot support as much debt as in the past, Boehlje says. He suggests funding with equity because it’s less risky and provides a cushion.
Less expensive capital allows you to grow faster, Boehlje says. "If costs go up, you may have to grow less rapidly."
Gloy adds now is the time to prepare for market changes. "Think about growing your business based on your equity. Equity is the ultimate insurance provider."
8. Make Investments in Operational Excellence. With any farm investment, Gloy and Boehlje say, your goal should be to make costs of production go down.
Make wise decisions that:
- increase efficiency and yields, improve yield stability and reduce operating costs.
- avoid poor capital investment decisions based on tax management.
- use cash reserves wisely.
- look at the net revenue gains associated with an investment.
- Spring 2011