Business Matters: Connect Dots On Hedge Accounts, Cash Sales

07:53AM Sep 28, 2016
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Most of us in production agriculture spend a massive amount of time watching the markets, but few of us have any idea where markets are going. As a result, many of us rely on our brokers or other market advisers for assistance. 

Relying on the expertise of those who spend countless hours analyzing massive amounts of technical and fundamental information is a solid business decision. Yet the ultimate decision-making responsibility still lies directly on our shoulders as producers. Often, producers are frustrated by advice because they provided insufficient or inaccurate information. Brokers and advisers are available to provide risk-management tools, not a crystal ball. 

Open Up Dialogue. There are 10 commodity-marketing principles that can help you better communicate goals, information and marketing plans with your broker. Connecting the dots between your hedge account and your cash sales, including basis, is the key to capitalizing on your marketing potential. 

1. Understand the true cost of production. Include every production expense such as family draws and overhead expenses funded by a marketing enterprise. For the growing crop, use five-year average production to assess cost per bushel.

2. Define sales increments. At what level are you comfortable enough to make sales or implement specific marketing positions? For example, your percentage might be 10%. Therefore, you will make sales in 10 equal increments per crop season.

3. Know incremental sales percentages. What is a 10% sale for your operation? If you produce 200,000 bushels of grain, 20,000 bushels is your 10% increment.

4. Identify the profit-margin target. If your profit aim is 15¢ per bushel and your cost of production is $4 per bushel, your goal would be to meet or exceed $4.15 per bushel through various marketing strategies and cash sales. Be realistic with the market. Not every sale or marketing position has a guaranteed profit. Unfortunately, some sales simply serve to limit risk or even a loss.

5. Identify the toolbox. Clearly identify with your broker which tools and tactics you are comfortable using. They include basis contracts, cash sales, options and futures positions.

6. Document the why. Write down why and how you intend to use each marketing tool. If you purchase a call option to make a higher (predetermined) cash sale at a later date, document the cost of the call and the cumulative net gain between the call option and the cash price needed to meet your margin target.

7. Fund each marketing year with a separate account. Track the benefit of your hedge account by funding each year individually. Start the marketing year with a set balance so once that marketing year is complete, you can see the net profit and loss. 

8. Document and tie each hedge account position to a specific sales increment of bushels. If you choose to purchase a put-option strategy on 20% of sales, those put options should be recorded on your cash-sales documentation system at the purchase price of the puts. Once the position is complete, either the cost of the puts or the net gain (if there is one) should be applied to that 20% of your grain once the specified sales increment is priced into the cash market.

9. Write down every position and define when a market segment is complete. For example, if your first 25% sale of the season was a cash sale, you can have peace of mind your first 25% of production is complete. With each incremental sale, you can focus on selling a smaller and smaller portion of your crop. 

10. Communicate and plan. Updating information weekly will help your broker understand your positions and specific goals as the commodity environment and your growing crop changes. 

Check In Frequently. As market conditions change and you stay in contact weekly with your broker, you’ll both be able to connect the dots more efficiently.