Fine-tune your farm business model
Pretty much every long-term model points to lower crop prices for the next few years, and that means tightening down the farm business management hatch. Experts suggest paying close attention to these nine points as you ramp up your competitive edge for 2014. –Ed Clark
1. Product Differentiation. One way to boost returns when commodity prices drop is to grow crops that sell for a premium. "Growing seed corn or seed soybeans is something people should look at," says Michael Langemeier, Purdue University economist. Unlike other ventures or acquiring land, growing seed doesn’t require a new set of production tools or a major investment.
2. Be a Low-Cost Producer. "This is the No. 1 way to boost your competitive advantage," says Gary Schnitkey, University of Illinois economist. "That means you can pay more for cash rent than anybody else and withstand lower prices." Two key ways to do this: Match machinery and fertilizer purchases to precisely what’s needed—not more. It’s easy to overinvest in both.
3. Calculate Cash Rent Profitability. "Make sure all cash rent land is profitable," Schnitkey says. For some high-priced rental ground that means either rents have to be negotiated lower, or if the landlord is unwilling, wise producers might have to walk away from the land.
4. Manage Downside Risk. Beyond astute marketing, producers are advised to take a hard look at crop insurance levels, Langemeier says. For some, investing in 80% coverage rather than 75% could be the best strategy if less coverage makes you too vulnerable to the downside.
5. Think Outside the Box. While not an opportunity for everyone, Langemeier sees the option for some crop farmers to add contract livestock to their enterprise mix. "Think diversification," he says, if you think crop prices could be low for several years. Creating nontraditional ag enterprises, such as vegetables, is another way to diversify but might take investment that takes several years to profit.
6. Use Realistic Planning Prices. For 2014 and beyond, adjust to the new price reality in the markets: Plan for $4.60 corn and $11 soybeans, Schnitkey says. In Illinois, average breakeven for corn is $4.40 to $4.50, factoring in all costs. A $1 per bushel decline in returns means $200 less revenue per acre.
7. Cash Is King. Ample liquidity in 2014 can help producers get through a rockier price road and put them in a stronger position to take advantage of investment opportunities, Schnitkey says. He recommends a 1.25-to-1 ratio of liquidity versus liabilities. Grain and other inventories are counted as part of liquidity because they can be readily converted to cash. Langemeier suggests that the ratio be 2-to-1, however, in part because commodity inventories can change in value so quickly. He also recommends that working capital to revenue be 30%—higher than in the past because price volatility has increased.
8. Shift Debt. As producers head into a period with tighter margins, it’s a mistake to be overly burdened with short-term debt because it takes away financial flexibility, Langemeier says. For example, don’t try to buy longer-term assets with short-term debt. "This got a lot of people in trouble in the 1980s," he says. Rather, try to match asset life with loan length. To get longer terms and lower payments, restructure debt if you need to. Despite the increase in long-term rates since mid-2013, they still are far below historical averages.
9. Develop a Growth Strategy. Langemeier says it’s important to have a growth goal and a strategy for achieving it that’s measurable. Likewise, he says it’s important to have target profit margins, again, accompanied by strategies.