Managing Farm Business Risk in a Volatile Economic Environment H. Douglas Jose Professor University of Nebraska Manitoba Agronomists Conference Winnipeg, December 9, 2008

Risk • Possible adverse event that has the potential to interfere with: –A business entity’s financial stability –Its ability to achieve it’s mission

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Framework Relationships

Risk

Mission & Goals

Strategic Planning

Business Growth

Industry Forces 3

Strategic Planning/ Positioning Strategy • Derived from “leader of an army” • Deception, ruse or intrigue Strategic Planning “A plan to overcome or deceive risk”

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Tactical Planning • Tactical planning is short term. “What are we going to do today.”

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Success is

“Converting risks into opportunities”

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Firm Level Risk Production:

• Weather, disease, pests • Technology application: biotechnology, mechanical, skills • Distribution channels & costs

Marketing:

• • • •

Channels & Marketing access Product standards Prices Contract terms 7

Firm Level Risk Financial:

• Interest rates • Debt servicing • Solvency

Human:

• • • •

Death Illness and injury Labour availability & performance Training 8

Firm Level Risk Legal:

• • • •

Liability Environmental Urban conflicts Regulation-labour, product specification

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Outline • Mission & Goals • Model of Business Environment • Risk Forces • Risk Actions • Risk Management Tools • Economic Situation 10

Mission Statements • Set the strategic direction for the business • Explain who the business is • Explain the direction and purpose of the business • Explain the values and uniqueness

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Mission Statements Example: Operate the family dairy business of sufficient scale and efficiency to: – Produce quality milk – Reward all workers – Provide opportunity for family and community involvement

With the overall goals of transferring the business to succeeding generations and generating positive community image. 12

Mission Statements Benefits • Initiates the strategic planning process • Unites family and stakeholders • Written documents encourage action • Basic roadmap for growth and change 13

Model of Operating Environment Business Chain Producer/Transformer

Raw Materials

Consumer Good Industry Forces Economic Forces

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Defining Environment Involves Visualizing:

“Visualize or Fossilize”*

* Steve Siemens, presentation to Nebraska Cooperative Extension Association, November, 2005

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Industry Forces * 1. Supplier Power 2. Buyer Power 3. Competition 4. Technology/production 5. Change agents * Adapted from Boehlje & Hofing, “Managing & Monitoring a Growing Production Agriculture Firm”. 16

Industry Forces 1. Supplier Power: Bargaining power of sources of inputs Force Factors:

•Concentration & control of supply •Impact on costs •Availability of substitutes •Threat of forward integration

Risk Impact:

Pressure on margins 17

Industry Forces 2. Buyer Power:

Bargaining power of customers

Force Factors: •Volume & leverage •Information •Substitutes •Taste and preferences

Risk Impact:

Increase pressure for quality and/or service; pressure on margins 18

Industry Forces 3. Competition: New or existing producers Force Factors: •Economies of scale •Cost advantages •Industry concentration •Entry costs •Entry and exit barriers

Risk Impact:

Pressure on margins and profits 19

Industry Forces 4. Technology:

Impact of technology on production and demand for product

Force Factors: •Lifespan •Ease of adoption •Impact on production and marketing chain

Risk Impact:

Pressure on margins and profits 20

Industry Forces 5. Change Agents: Forces imposing change Force Factors:

•Government policies •Government regulations •Economic conditions •Trade agreements

Risk Impact:

Industry level risks 21

Summarizing Business Environment Force ____________________ Situation/Impact____________ Major Issue________________ Response__________________ 22

Risk Actions Retain: Opportunities are greater than risks Reduce the odds & chances of risk occurring: • Variety selection • Market timing • Careful financial management

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Risk Actions Mitigate: Reduce impact • Cash Reserves • Safety first strategies

Transfer: Transfer to others • Insurance • Sales contracts

Avoid: Consequences are high

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Risk Management Tools Production Risks – Seed Selection • Evaluate traits • Compare costs and risks

– Breakeven analysis with risks factors – Caution with suppliers – Crop insurance

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Risk Management Tools Marketing Risks – Future market tools • Understand the tool and the strategy

– Seasonal trends • Still useful

– Contractual arrangements • Understand conditions • Know contracting partner and their situation

– Move from commodities to products 26

Risk Management Tools Financial Risks – Understand the Basics of Financial Analysis 1. Balance Sheet Analysis – Debt to Asset Ratio or Percent Debt

Green: Yellow: Red:

< 30% 30-60% > 60%

2. Balance Sheet Trends – Key: Change in Net Worth

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Risk Management Tools Financial Analysis 3. Current Ratio – Current asset/Current liabilities

Green: Yellow: Red:

> 2.0 1.0-2.0 < 1.0

4. Working Capital – Current Asset-Current liabilities – 20% of expenses or revenue

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Risk Management Tools Financial Analysis 5. Plan the use of profit 60-30-10 Rule * •

60% Devote to increasing earned net worth

•

30% Devote to building working capital

•

10% Discretionary

6. Involve accountants and lenders 7. Budget a number of “what if” scenarios. * David Kohl, “Farm Management in the current financial situation”, Market Journal, marketjournal.unl.edu, October 10, 2008. 29

Risk Management Tools Human Risks – Transition plan • Communicate • Include transition of management and assets

– Relationship Development & Maintenance • Family • Employees • Business contacts • Landowner- if renting land • Other farm business operators 30

Risk Management Tools Legal Risks – Understand environmental and zoning obligations and liabilities – Understand business liabilities

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Risk Management Tools Quality Management Control – Tasks, responsibilities and timing. *

John Lawrence, Quality Management Control, Market Journal marketjournal.unl.edu, November 21, 2008.

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Risk Management Tools Non-farm income will continue to be an important farm family risk tool.

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Source: Farm Income Forecast Highlights, www4.agr.gc.ca/AAFC_ACC 34

Risk Assessment/Scorecard Risk

___________

Consequences or Impact __________ Likelihood or Chance

___________

Action

___________

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Current Financial Situation

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Economic Forces LIBOR “London Interbank Offered Rate” – Rate banks charge each other for short term euro dollars – International rate to borrow U.S. dollars in the London money market. – Includes a risk factor which U.S. treasury rate does not. 37

LIBOR Rates as of November 30, 2008

This Week

Month Ago

Year Ago

1 Month LIBOR Rate

1.44

3.17

4.81

1 Year LIBOR Rate

2.74

3.51

4.44

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Credit Markets • Liquidity is not the issue. Concerns are: – Profit margin – Financial risks – Asset values

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Food Costs • Food versus fuel is a non-argument.

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Index Prices

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Fundamental Value of Corn Maximum Bid Price of Ethanol Processor for Corn After: Crude Oil Price $/bbl. 60 70 80 90 100

Variable Costs All --$/bu.-3.35 3.97 4.58 5.19 5.81

Costs 2.53 3.14 3.75 4.37 4.98 42

Economic Forces “The key talent in the future will be the ability to deal with the tremendous technological and cultural changes that are coming at an ever increasing pace.” John Mauldin “Frontline Weekly Newsletter” Nov. 27, 2008

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Economic Forces “Globalization is not just a manufacturing and sales process. It is also an intellectual process” John Mauldin “Frontline Weekly Newsletter” Nov. 27, 2008

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Summary 1. Generate Model of Operating Environment. 2. Determine and assess priority risks. 3. Devote attention to financial analysis. 4. Maintain global perspective.

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Doug Jose University of Nebraska-Lincoln [email protected] Marketjournal.unl.edu

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