$2 Cotton Can Lead to Bankrupt Farmers!
Feb 15, 2011
Now that cotton is rapidly approaching $2 a pound or corn is over $7 a bushel, many people feel that farmers now have it made and the good times will always be here. What I have seen in my career is that almost the exact opposite may happen. Many farmers (or other business people) get a false sense of security that high prices will remain high. However, we know through out history, high prices always lead to one thing and one thing only - LOW PRICES at some point.
Generally, when prices are high, farmers that get in trouble tend to do the following:
- Expand their operation by buying high priced land,
- Expand their machinery base by purchasing more expensive and newer machinery,
- Defer the sale of their crops to escape the tax man,
- Expand their personal living lifestyle to include more trips, larger house, etc,
- Replace liquidity with long-term assets.
Now when prices remain high, almost all of these situations can be handled by the farm operation. However, when prices start to adjust and if they by chance remain close to their lows for at least two years, any farmer that has done at least three of the above five items will either go bankrupt or have massive liquidity issues to deal with.
As an advisor, I would recommend that a farmer take advantage of these good times by doing almost the exact opposite of what is shown above. In other words, when prices are very good, a farmer should:
- Keep their lifestyle the same or even reduce their living expenses,
- Pay the tax man with these high priced commodities, if you defer it, you will most likely get a lower price and owe no tax,
- Not covet the neighbor's half-section, but rather wait for the price adjustment and buy it for cash when times are bad,
- Expand their liquidity to at least 50% of annual sales,
- Keep their machinery for another year or two
If farmers do a great job of this, they will have substantial more net worth to use to acquire land when the prices adjust.
Which farmer do you want to be?