Managing Farm Business Risk in a Volatile Economic
Environment
H. Douglas JoseProfessor
University of Nebraska
Manitoba Agronomists ConferenceWinnipeg, December 9, 2008
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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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Strategic Planning/ PositioningStrategy• Derived from “leader of an army”• Deception, ruse or intrigue
Strategic Planning“A plan to overcome or deceive risk”
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Firm Level RiskProduction:
Marketing:
• Weather, disease, pests• Technology application:
biotechnology, mechanical, skills• Distribution channels & costs
• Channels & Marketing access• Product standards• Prices• Contract terms
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Firm Level Risk
Financial:
Human:
• Interest rates• Debt servicing• Solvency
• Death• Illness and injury• Labour availability & performance• Training
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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
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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 StatementsExample: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.
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Mission StatementsBenefits
• Initiates the strategic planning process
• Unites family and stakeholders
• Written documents encourage action
• Basic roadmap for growth and change
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Model of Operating Environment
Business Chain
Raw Materials
Consumer Good
Producer/Transformer
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”.
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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
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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
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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
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Industry Forces4. 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
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Industry Forces
5. Change Agents: Forces imposing change
Force Factors: •Government policies
•Government regulations
•Economic conditions
•Trade agreements
Risk Impact: Industry level risks
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Summarizing Business Environment
Force ____________________
Situation/Impact____________
Major Issue________________
Response__________________
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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 ToolsProduction 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 ToolsMarketing 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
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Risk Management ToolsFinancial Risks
– Understand the Basics of Financial Analysis1. Balance Sheet Analysis
– Debt to Asset Ratio or Percent Debt
Green: < 30%Yellow: 30-60%Red: > 60%
2. Balance Sheet Trends
– Key: Change in Net Worth
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Risk Management ToolsFinancial Analysis
3. Current Ratio– Current asset/Current liabilities
4. Working Capital– Current Asset-Current liabilities
– 20% of expenses or revenue
Green: > 2.0Yellow: 1.0-2.0Red: < 1.0
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Risk Management ToolsFinancial Analysis
5. Plan the use of profit60-30-10 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.
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Risk Management ToolsHuman 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
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Risk Management ToolsLegal Risks
– Understand environmental and zoning obligations and liabilities
– Understand business liabilities
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Risk Management ToolsQuality Management Control
– Tasks, responsibilities and timing. *
John Lawrence, Quality Management Control, Market Journal marketjournal.unl.edu, November 21, 2008.
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Risk Assessment/Scorecard
Risk ___________
Consequences or Impact __________
Likelihood or Chance ___________
Action ___________
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Economic ForcesLIBOR
“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.
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LIBOR Rates as of November 30, 2008
This Week Month Ago Year Ago
1 Month LIBOR Rate 1.44 3.17 4.811 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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Fundamental Value of CornMaximum Bid Price of Ethanol
Processor for Corn After:
Crude Oil Price Variable Costs All Costs$/bbl. --$/bu.--
60 3.35 2.5370 3.97 3.1480 4.58 3.7590 5.19 4.37100 5.81 4.98
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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.