Editor’s note: This is the second of two articles discussing farm stress testing. Read part one on why to stress test here.
Stress testing is an exercise in “breaking your farm,” a valuable tool in identifying budget and operational vulnerabilities, how they influence your farm’s working capital and what changes should be implemented to make your farm more resilient. While there are a lot of reasons to stress test , one of the most important is the answers it provides to “what if” questions. Stress-testing can be completed in the following four steps.
Step 1 — Assemble your budget and understand working capital requirements.
Stress testing for your farm starts with having a comprehensive understanding of your budget, including working capital requirements, or the ability to manage your financial obligations on a daily basis.
“Stress-testing is quantitative,” said Spokane, Washington-based Conterra Ag Capital Vice President Relationship Manager Jeff Hardin. “You need to sit down and construct a solid, granular 12-month budget where you’re breaking things down by commodity. The point of it is to understand every crop’s costs and returns, then focus what can affect those things. Stress testing helps quantify what’s happening and everything you can control. The budget should be in a spreadsheet like EXCEL so that you can quickly show the impact of your stress assumptions. Your operating lender and/or accountant can help develop the budget.”
For a grain farm, include items like the following in your budget spreadsheet:
- Fixed costs: Depreciation, interest, land rent, taxes
- Variable costs: Seed, fertilizer, herbicides, crop insurance, labor
- Expected revenue: Projected crop acres, yield, prices.
- Financial requirements: Working capital, cash flow, operating capital
Step 2 — Apply stressors to your budget.
Next, adjust your budget spreadsheet to account for different stressors. It won’t necessarily give you crystal-clear answers, but it can show how changes to various parts of your budget can impact your overall financial performance.
Within your spreadsheet, account for stressors such as:
- Abrupt fall in commodity market prices
- Abrupt rise in interest rates.
- Extreme weather that cuts your farm’s output
- Timing changes in cash flows including delayed marketing and slow payment of receivables.
- Catastrophic equipment or machinery failure
Step 3 — Run worst-case scenarios.
Next, consider how each abrupt change could influence your farm’s financial viability. Create a set of “worst-case scenarios” that can reveal where your operation is most vulnerable, then consider the concrete steps you can take to maintain working capital for your operation.
“You can run these stressors against your budget to see how it could affect you and how you can respond,” Hardin said. “This helps you visualize the impact so you can make the right changes. Improving your working capital is a big way to account for the stress of the unexpected.”
Step 4 — Take action.
If you’ve stress tested your farm budget with an abrupt grain market decline or sharp interest rate increase for example, you can mitigate those scenarios. One adjustment you can make is sell earlier and get paid sooner; then make that money work for you.
“Don’t wait around to get paid. Make efforts to get paid on receivables as soon as possible and get money into the bank. You can reduce your overall operating loan interest bill, even if it’s just for a week,” Hardin said. “Manage with the goal to reduce your average daily loan balance that interest is accruing against. You can re-borrow that money later when you need it with your revolving line-of-credit.”
Get in touch with Conterra if you’d like to stress test your farm or take action to improve your farm’s financial and working capital standing.