Editor’s note: This is the first of two articles discussing farm stress-testing. Read part two on how to stress test here.
Ask farmers a historical question about the last major storm to hit their farm and wipe out their crop and they will likely respond with an exact date, weather details and what they did to recover. The same goes for grain marketing — memories of when they sold at peak prices and when they scraped the floor of the market are vivid in many farmers’ minds. The same isn’t always true when it comes to thinking of today moving forward. That’s where farm stress testing comes in.
Stress testing a valuable tool in knowing where your operation sits from a financial standpoint today and what you need to do to secure its future. Here are a few reasons why it’s a good idea to stress test your farm.
1. Stress-testing exposes your vulnerabilities.
Farm stress testing fleshes out some of the worst-case scenarios that could “wipe out an operation,” according to Conterra Ag Capital Vice President Relationship Manager Jeff Hardin. It enables an ag business owner to plan for how to react and adapt to sustain working capital if one of those scenarios unfolds.
“Stress testing is an exercise to “what-if” your company should reality not meet budgeted expectations,” said Spokane, Washington-based Hardin. “You can essentially show what it would take to go out of business. It’s not a happy scenario to think about, but it is very illuminating and can show you where you have vulnerabilities, then give you the opportunity to shore them up and even exceed budget.”
2. Stress-testing has short- and long-term value.
An abrupt increase in fuel costs or interest rates, for example, can alter expenses enough to increase operating capital requirements and, as a result, borrowing needs. If you can uncover the general implications of changes like these through stress testing, you can plan ahead to prevent the financial fallout. Farm stress testing has long-term value in terms of what you pay to maintain necessary liquidity over time.
“If petroleum prices increase, your fuel and fertilizer prices will increase. Say you have to take money out of your operating line of credit to pay fuel bills higher than you had budgeted. Now you have borrowed more money earlier, so not only are your fuel costs higher, but so is your daily loan balance. That means annualized operating interest costs will go up,” Hardin explained. “That leaves you with some potentially tough decisions to make to maintain your liquidity.”
3. Stress-testing reveals operation-wide issues.
In Hardin’s region of the Pacific Northwest, many farmers raise a high number of commodities. Sometimes stress-testing reveals that switching to a new crop mix can make the farm more resilient if abrupt changes become financially draining.
“One farmer I’ve worked with had 300 acres in his crop rotation that never really produced a profit. When we started stress testing, we found that it would probably never be profitable for him,” Hardin said. “So why even farm it? He made some decisions, got rid of those acres and now he’s in a much stronger financial position.”
4. Stress-testing aids in confident decision making.
A major goal of any stress testing is to improve working capital. Stress testing helps farmers make confident decisions and adjustments to their operations.
“Currently, owned land represents the best source of capital most farmers have. If you are in a stressed working capital scenario with low commodity margins and high debt service requirements, you should consider refinancing some of that land at current historical low rates to restructure existing debt and inject cash. You can lock in those rates over a long period of time,” Hardin said. “If you’ve got a 40-acre parcel that’s not performing, maybe it’s time to convert that land to cash through a sale to put back into other areas of your operation. Stress testing provides clarity to these types of decisions.”
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.
