insurance contract

Risk Transfer (a.k.a Insurance)

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I spend a lot of time thinking about risk management. Often the focus is around “cost-benefit” and the “what-ifs” that need to be applied to every business decision we make. But recent conversations with some of my insurance buddies have sparked this writing and a discussion on how you can take advantage of risk transfer.

Risk transfer is as the name implies: you are transferring the risk of harm to a third party. That third party wants to be paid to take the risk, and as such asks you to pay a premium. This is nothing new for almost all of us.

There is a piece of this equation that may be unclear for some people. Similar to how a lender won’t finance 100% of the value of an asset, insurance companies won’t necessarily insure 100% of the value of an asset. They need some comfort in knowing that you will also incur a loss in a claim situation which they expect would incite you to take appropriate measures to protect the asset. This coverage gap, combined with the deductible, is the risk you retain. The amount of risk you wish to transfer (insurance coverage) and the amount of risk you are prepared to retain determine the amount of the premium that the insurer will expect. Again, this is nothing new, but the part that is often overlooked is the value of the asset in the policy.

A couple of years ago, I made a referral in to an insurance broker for a full farm review. What the broker discovered was that a brand new fully loaded farm shop was insured for replacement value, but only for $20,000 in contents. This was easily $80,000 too low based on what was actually contained in this particular shop. In this situation, the insured (the farmer) had to acknowledge 1 of 3 things:

  1. He chose to retain $80,000 of risk (plus deductible) if the shop and contents were a total loss;
  2. He was unaware that he was grossly under-insured;
  3. He was unaware of just how much the contents of his shop were valued.

In this example, the farmer was poorly advised in 2 of 3 points above because “being unaware” of coverage gaps is an excuse your insurer won’t feel sorry for, nor with they pay. The other point (retaining the risk) may have been strategic, but the broker doing the review did an excellent job of identifying these kinds of coverage gaps. When assets are bought, sold, or used up & discarded, the effect on your insurance coverage can be significant. If you have not reviewed your coverage thoroughly for a few years, you may be holding coverage that is far from meeting your needs.

The other aspect of risk transfer that is too often ignored is liability. Liability is very affordable, yet, according to many insurance advisors I speak with, it is rarely included to a suitable scale in farm risk management strategies.

Direct Questions

When was your last insurance review? Like your business plan, your crop plan, and your estate plan, your insurance plan should be reviewed at least annually.

How well can you describe your liability coverage on your farm? What is covered? What is not covered? Can you afford to find out AFTER an insurable incident?

Do you have contractors, salespeople, and visitors on your farm at any point through the year? Are you covered if they get hurt while on your premises? What about on your rented land, who is liable: landlord or tenant?

From the Home Quarter

My company and I carry different kinds of insurance for different reasons. For your interest, I carry a Commercial General Liability policy. This covers me when I’m on YOUR property. YOU can take solace in knowing that if I should somehow cause damage to your property, I have paid to transfer that liability to a third party.

The risk you face from allowing an uninsured person onto your property can be staggering. Imagine the ramifications if a delivery of anhydrous ammonia went wrong while a visitor was on your property? If that visitor, or the driver, was seriously injured from the NH3, and if your supplier was not covered or insufficiently covered, the ball gets handed to you. Make sure that those who you allow on your farm carry their own coverage, and ensure you have your own coverage too.

sustainability

The RISK 2-Step

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Here is a quote I recently read that was attributed to John D. Ingalls in Human Energy:

“The degree to which ambiguity can be tolerated determines the amount of difficulty
the individual can, and is willing to, meet and overcome in coping with the problems of
human life and in taking advantage of the opportunities life has to offer.”

Let’s make a few changes and see how it applies to business:

The degree to which risk can be tolerated determines the amount of variability the
business owner can, and is willing to, accept and manage in coping with the cycles of
business and in taking advantage of the growth opportunities that risk presents.

A good fair portion of any given week has me speaking with some very smart farm business owners,
lenders, and other business advisors. I continue to hear the same message: “guys (farmers) just don’t
understand the risk they are taking when they “

Risk is something every entrepreneur faces. We get paid for taking risks, and the more risk we take, the
higher the expected payday. Of course we all also recognize that the more risk we take, the greater the
potential loss as well.

But isn’t that pretty much what John Ingalls said above (or at least the paragraph I amended?

  • The risk averse cannot tolerate variability, is unwilling to manage cycles, and fails to capitalizeon growth opportunities.
  • The risk ardent embrace variability and cycles as opportunity to grow and expand.

The first step in being rewarded for taking risk is understanding the risk. It cannot be understood until is
acknowledged. Acknowledgement happens either when one steps out of his comfort zone and takes a
good hard look around, or when an outside party brings their perspective to the table, such as a
creditor, who might for example, change the terms of the relationship due to an inappropriately
managed risk.

Acknowledging that a risk exists, and recognizing its potential impact on your business can often be
difficult, scary, or even embarrassing. It can be hard to admit that we don’t know or understand
something that we (society) feel(s) we “should know.”

The second step in this 2-step, once you understand the risk, is to manage the risk. You’ve heard me say
many times “you can’t manage what you don’t measure,” which holds true for risks as well. Managing
the risk takes an understanding of how it could affect your business, measuring that effect and the
opportunities to mitigate the risk (think of it as a projection of best case and worst case scenarios.)

What does this all mean from a practical standpoint? Let’s consider a real world example from 2015.
Many growers were struggling on whether or not to apply fungicide to their durum. They were looking
for ways to reduce costs. The crop wasn’t looking so great (frost in late May and no rain until mid-July.)
The environmental factors that contribute to high fusarium were not as apparent as 2014.

The risk was the potential detriment to crop yield and/or quality from eliminating the fungicide
application to durum in 2015.

To understand and manage the risk, here are some questions that needed to be addressed:

  • How much damage can you withstand before lower quality grading eliminates profit potential?
  • How will lower grading affect ability to sell/deliver? (impact on cash flow)
  • Is there enough crop now growing to pay for the cost of fungicide if grade and yield are 100% protected? (cost/benefit consideration)
  • Is the crop at an even enough maturity to facilitate proper timing of the fungicide application?

Once these, and many other, points have been given appropriate consideration, one can make the best
management decision he/she can. In the case of the 2015 durum fusarium issue, some farmers sprayed
and still had toxic levels of fusarium; others didn’t spray and had manageable levels of fusarium. The
outcome is never guaranteed, but the process empowers you to make the best decisions possible.

Direct Questions

How are you determining which risks to pay attention to, which risks to manage, and which risks to
simply live with?

Even if you can’t dance, The RISK 2-Step does not require fluid movements or talented feet, but may still
require a lesson or two; who is interested in some “dance” lessons?
Are you risk averse or risk ardent? Knowing is important in being able to manage risk.

From the Home Quarter

Don’t kid yourself when answering the 3rd Direct Question above. We all know we need to be able to
handle some risk; my goodness, if we couldn’t, we wouldn’t be able to farm! But deep down at your
core, how do you handle risk? Consider this the “warm up” before stepping onto the dance floor for The
RISK 2-Step: truly acknowledge where your approach to risk lies, and then start the dance.

grass

BMP – Best Management Practices

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BMP’s, or Best Management Practices, are also often referred to as “Best Practices.” Commonplace in
corporate culture, the primary benefit served by BMP’s is bringing consistency to methods or techniques
used to accomplish a task or objective. Also focusing on efficiency and ensuring the best use of available
resources, BMP’s are everywhere, even if they aren’t documented in a manual somewhere.

Your farm is no different. Over the years, you’ve likely established a BMP for the way in which you
service the combines in season. With good harvesting weather typically in short supply (especially this
year) you’ve got “a system” for how you deal with blowing out filters, cleaning windows, greasing,
fueling, and the circle check you do to identify trouble spots like belts, bearings, and chains. If, and
when, you have new employees on the farm, how do you convey your “system” to them?

Is it fair to say that the Best Management Practice you’ve worked out for servicing combines, for
example, isn’t available in an employee handbook, or even on a notepad somewhere? It’s in your head.
It’s just what you do. It’s habit. It’s automatic. It’s common sense.

What may be a common sense natural work flow to you might be as abstract as a foreign language to
your new helper, your spouse, or your kids.

You may have felt the same angst as your new helpers at harvest while listening to your banker describe
the nuances of your financing arrangement, or your lawyer discussing tax implications. It can feel like
they are speaking a different language.

In your business, communication is the answer. Any best practices you have developed over time
(documented or not) are useless if not effectively communicated to the right people.
Best Management Practices apply to many aspects of your business, such as:

  • Managing financial data
  • Processing invoices
  • Servicing equipment
  • Soil conservation
  • Employee engagement
  • Etc.

This list is by no means exhaustive and could go on & on. There is likely a best practice you could think of
for just about everything in your business.

Direct Questions

How many specific Best Management Practices do you already have in place on your farm? How many
are documented?

How could your stress level be reduced in the busy season if you had BMP’s documented for new
helpers to review and be comfortable with prior to “trial by fire?”

It isn’t realistic to implement a BMP for every task on your farm, but what would it take to do so for the
most critical functions that take place through the course of a growing season?

From the Home Quarter

Best Management Practices are everywhere, they are all around you whether or not you see them, have
formalized them, or even give them a moment’s consideration. They have helped you expand, do more
with less, and streamline workflow. They are available in all aspects of your business, if you chose to
seek them out and implement them.

Over the winter, I will be spending time with each of my clients working on several issues, with one
being Best Management Practices. If you’re interested in learning more, please email me or call
anytime.

planning

Financial Literacy Month

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November is Financial Literacy Month, an initiative of The Financial Literacy Action Group which is “a
coalition of seven organizations that work to assist and improve the financial literacy of Canadians.”
http://www.financialliteracymonth.ca/About-FLAG/

Watching some news the other morning while having breakfast, I saw a financial commentator discuss 3
simple financial questions to which Canadians have averaged 1.8 out of 3 correct answers. And trust me,
these were SIMPLE questions. But anyone who knows me knows that I will always acknowledge that
“you don’t know what you don’t know.”

That being said, there is no shame in not knowing what you don’t know. It is when you don’t know what
you should know that risk is increased. Here is a short quiz for you to take regarding your farm financial
literacy for the occasion of Financial Literacy Month.

1. Your current assets are MORE than your current liabilities. This means your working capital is
a. Negative
b. Positive
c. I don’t know

2. Your contingency fund (emergency cash) has a balance of $50,000 in a savings account earning
1% interest per year. If inflation is currently 2%, then the net real value (the buying power) of
your contingency fund after 1 year is
a. More than $50,000
b. Exactly the same as the start: $50,000
c. Less than $50,000

3. The tractor you bought last year for $200,000 can be sold today for $215,000. You’ve claimed
$30,000 in depreciation on that tractor, meaning it has a book value of $170,000. You’ve just
sold the tractor for $215,000, and now you will have a
a. $45,000 capital gain
b. $15,000 capital gain
c. $30,000 recaptured CCA
d. Both b) and c)
e. None of the above

4. My banker is always in a hurry to see my financial statements because
a. He’s looking for a way to increase my interest rates
b. They need to ensure I’m still a good credit risk
c. She’s trying to lend me more money

5. I’m a farmer; I don’t need to know all those ratios and analysis and stuff.
a. True
b. False

While these questions I’ve posed to you aren’t the simplest questions that everyone should know, they
will create a benchmark for you to get an idea of what you do know and where your mindset is. At the
end of the day, it is up to you to determine if and how you will tackle the imperative task of advancing
your farm financial management. In a bit of shameless self-promotion, I have developed a classroom
seminar titled Advancing Your Farm Financial Management.
https://fbdi.gov.sk.ca/LP_LearningActivityDetail.aspx?id=Q6UJ9A03H15A&area=Financial+Management

It is a one day commitment. It has been developed for the farm business owner who wants to take his
basic financial knowledge to an intermediate level. It has been approved for reimbursement under the
Farm Business Development Initiative. http://www.agriculture.gov.sk.ca/GF2-FBDI

Course participants will learn what is important to their banker and why. They will develop an
appreciation for the risks all farmers face, plus the risks to their specific farm and how to mitigate those
risks. Each participant will go home having built the foundation of their own personalized financial
management plan. And the best part: lunch is on me!

Direct Questions

When it comes to financial jargon, the importance of financial management and how to use the
information, if you don’t know what you don’t know, who will you call for help?

I hear it is not uncommon to pay upwards of $10,000-$20,000 to your equipment dealer for them to go
through your combine to ensure everything is up to par. What is it worth to do the same for your farm’s
finances? Do you do it as often as you do for the combine?

From the Home Quarter

In a business with as much inherent risk as production agriculture, ignoring certain aspects of your
business increases risk exponentially. And whether that ignoring stems from a lack of interest or
understanding or time, the risk does not simply go away because it has little attention paid to it…in fact,
it grows. To create an analogy, ignoring risk is like ignoring a weed in your field: pay little attention to it,
it still grows; deal with it right away, and you increase your probability of a successful crop.

In the spirit of Financial Literacy Month, I challenge everyone to become more fluent in one new
financial term each week in November.

And for the answers to the quiz above, send me an email.

Our proprietary Farm Financial Analysis provides you with a straight-forward, easy to read report of
your farm’s financial position with focus on areas of strength, caution, and danger. Call or email for
more details.

emotion

Performance Management: A Post-Harvest Checklist

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With harvest done, or nearly done, across the prairies, this is the time to engage in a little retrospect.
Recognizing the window is small (and shrinking) to get all the fall work done before freeze-up, this task
may end up a notch or two down the priority list. But nonetheless, it is important to go through this
exercise now that the crop is in the bin.

1. Evaluate actual yields against expected yield
Determine why your yields did, or did not, meet expectations. Not meeting expectations could
be positive or negative, and knowing what you did to control the outcome is important to either
repeat the practice, or learn from the shortcoming.

2. Assign a value to your production
This will be a combination of the prices you’ve already contracted and the current street price
on unpriced grain. Be accurate here; it does you no good to overstate the value or quantity of
your inventory.

3. Determine your current Working Capital
Once you’ve got a value for your total grain on hand, consider the rest of your current assets
and current liabilities to determine your working capital. This is the point in each operating year
(right after harvest) where working capital should be strongest. If it currently is not, seek help.

4. Production Cost and Fixed Cost Review
Looking at your whole operation as one figure does not provide sufficient information to afford
opportunity to increase management and profits. Break it down by crop and by acre. Where are
your positive points? Where are your stress points? What was your equipment cost per acre on
your cereal crops in 2015? What is your unit cost of production on that new land you rented this
year?

5. Field and Crop Analysis
Which fields were profitable? Which crops were profitable? Did you have significant variability
in some fields and/or crops? If so, how are you managing that?

6. Cash Flow Projection
Working capital versus future cash obligations gives you a clear understanding of what your cash
flow will look like over the next several months. Consider your expected cash flow in the near
term with your projections for 2016 (you will be working on those, right?) Does this affect your
expectations for next year?

7. Current Year Tax Analysis
There are less than 10 weeks remaining in the calendar year, and if your year-end matches the
calendar, you’ve got a small window of time remaining to determine what your tax situation will
look like and enact prudent business decisions accordingly.

8. Accrual Financial Statements
Whether you are incorporated or not, you should be having your accountant prepare financial
statements. If those statements have not been accrued in the past, please start now. Accrued
financial statements are the only way to truly gauge your business performance for the fiscal
year. (HINT: old statements can be accrued and presented again for management purposes.)

From the Home Quarter

One of my favorite adages is “If you don’t measure it, how can you manage it?” You’ll notice that the
essence of the points in the check list above is heavily weighted on measuring results. Any advancement
towards innovation in your business is lost if results are not accurately measured. Take the time now
that you’ve got the time to collect your data, analyze the results, and manage your performance.

doit

Soil Testing

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It’s soil sampling season. Hundreds of thousands of fields are yielding to the soil probe as farmers,
agrologists, and retailers are pulling cores as fast as they can before freeze up. The soil test is a crucial
decision making tool in planning the next year’s crop. Understanding each field’s organic matter,
residual nutrient levels, and pH levels are but a few of many factors that all come together in a soil test
report to allow you to make an informed decision on what it will take to produce a crop that meets your
expectations. Soil experts suggest that every field be soil tested every year. They surmise that each field
should be treated as unique and that using a whole-farm, or even crop specific, fertility management
strategy is not financially efficient. To paraphrase, how can one make decisions about fertility without
knowing what is currently available in the soil?

Despite some arguments that the unused nutrient can remain in the soil for future crops
(notwithstanding the varying disagreements over nitrogen losses,) over-fertilizing will use up working
capital in the current year. Under-fertilizing can limit your yield potential. Both are manageable risks.
So the question begs, “Why don’t all farms soil test all fields every year?”

“Labor” is part of the answer, so is “time.” If “cost” forms part of the reply, I have to seriously consider
mindset. What is the cost of a soil test on one field when measured against the risk of over, or under,
fertilizing? (Not to mention the value in being able to validate changes in your soil over the years.)
I would connect the same mindset to understanding a farm’s financial position before making business
decisions. Many farmers still do not make knowledge of their financial situation enough of a priority and
continue to make substantial business decisions based on emotion, or gut feeling. Pulling together your
net worth, income/expense, and cash flow statements provide you the same informed principles when
making financial business decisions as does the soil test when making crop and fertility decisions.
Understanding your farm’s financial position is crucial to making business decisions. Identifying how
your profitability, your equity, and your cash flow will be affected allows you to make informed choices.
These effects, once appreciated, can be measured against your business and personal goals to allow for
prudent and strategic business resolutions.

This leads directly into the heated debate over Big Data or Ag Data or whatever buzz word you prefer to
use. Without stepping onto that stage, the basis of the argument is the same:

  • Knowledge is power.
  • Uninformed decisions increase risk.
  • You can’t manage what you don’t measure.

While managing ALL you farm data is critical to the future of your success in the industry, I’m not
insisting that getting on the data train be 100% completed by everyone this winter. Like with anything
new, there are innovators & early adopters, and there are laggards, but the majority of us are
somewhere in between. Get over the mindset that the soil test is an excuse for retailers to sell you more
inputs; get over the mindset that “big data” will one day . This is about your business and how you can make
the most informed decision possible. Remember, you can only make informed decisions with quality
information.

Direct Questions

Would you write a cheque without knowing your bank balance? Would you accept regular information
from your bank that was “close,” or do you demand accurate reports each month?

Your soil test creates your “soil balance sheet.” Are you investing adequate time and effort into your
“financial balance sheet?”

The appropriate time for soil testing is after harvest but before seeding; once per year. How often are
you measuring your financial status? (HINT: it should be much more than once per year.)

From the Home Quarter

The parallels that can be made between doing a soil test and doing a financial review are many. While
there are subtle differences as well, the analogy is somewhat uncanny. Mindset comes up in this
discussion, as does data. In the end, it’s up to each business owner to decide how he/she will make
management decisions: with quality information leading to knowledgeable decisions, or by intuition
relying on emotion and gut-feeling. They’re almost as different as “black and white.”

Our Farm Financial Analysis service is akin to a report card, or a soil test report, of you farm financial
status. You get a clear and direct summary of strengths and weaknesses. It will also act as an indication
of the quality of your information (two benefits in one!) Post-harvest is probably the best time for a
Farm Financial Analysis so that you’re afforded opportunity to make changes (if necessary) before your
fiscal year end. Call or email for details.

GFP FI 2

Managed Risk – Part 5: Inaction

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While there could be many more “parts” to the list of topics that would fall under “Managed Risk,” I’ll
end it this week with one that I believe many people, maybe all people, face each day.
The list of reasons (excuses) we provide to support our decision not to act is virtually endless. They can
be found in the 7 Deadly Sins (pride, envy, sloth) or in almost any self-help book (communication issues,
inequality, stress) or even from psychological therapy (apathy, self-esteem issues, narcissism.)
Here are a few of the most monumental farm issues that are affected by inaction:

Business Structure

I recently took a call from a young man looking for guidance on how to manage the complexity of his
current farm arrangement. He farms with his dad and his brother; all three men have their own
corporation and their own land; one brother farms full time with the dad, the other is part time with offfarm
work. Tracking financial contributions and division of labor are a nightmare, and yet both look like
a cakewalk compared to managing “whose inventory is whose?” They are not happy with the increased
efforts needed to deal with these issues, they all know that there is likely a better way, but no one has
taken a step until the day I spoke with one of the brothers.

In this case, the inaction stems from unawareness: none of the men involved in this family farm had the
knowledge of what, if any, options were available, what questions to ask, or who to even ask for help.
It’s also common for inaction to stem from fear – fear of appearing incompetent by asking a “dumb
question,” fear of making the wrong decision, fear of rocking the boat and hurting the family dynamic.

Family Issues

Family issues challenge most intergenerational farms. There are many varieties, and most are worthy of
a book being written on the topic. Elaine Froese wrote Farming’s In-Law Factor. There should be books
written on “How to Fire Your Father” and “Decoding Motivation: How to Translate Boomers, Gen X’ers,
and Millennials.” If only…

The most common reason for inaction on family issues is “I don’t want to blow up the farm.” The
problem is that inaction can blow up the farm with greater odds than if action was taken! Unless the
family member you’re dealing with has truly sinister motivations, the likelihood of a successful dialogue
is quite positive. No one wants to destroy the farm or the family, so with the appropriate approach,
success can be had. The inaction for family issues predominantly stems from fear. Coaching is available
to help families deal with these types of issues.

Transition

Considering the average age of a Canadian prairie farmer today, the volume of farm transitions to take
place over the next 10 years is staggering. The cumulative value of assets that will change ownership
would dwarf the GDP of some small nations. With so much at stake, why does every farm not have a
succession plan already in place (or at least in progress?)
Inaction on this front increases the risk of the following:

  • Future family fighting
  • Colossal tax obligations
  • Destroy the farm business
  • Your legacy lost

Excuses (reasons) for inaction here are unacceptable. It is nothing short of reckless and irresponsible to
leave undone a function with such enormous impact. There is no shame in not having all the answers, or
any answers for that matter. Farm transition is a process, not a result. The process becomes a path of
discovery, but if you insist on keeping your blinders on, don’t be surprised to one day deal with any or all
of the 4 bullet points above.

Direct Questions

What is your main reason for inaction? “No Time” is an excuse. “Fear” is a real reason, but only you can
conquer it.

What have your accountant and lawyer provided you for advice regarding your future transfer (sale) of
assets?

In a family business, inaction increases the probability of irreparable family dysfunction. What is getting
higher priority: family harmony or fear of perceived conflict?

From the Home Quarter

What must happen to make an issue a priority? Is it an immediate tangible loss/damage, like an
equipment breakdown in season? Is it emotional goal, like a new pickup truck? Is it perceived (assumed)
risk, like assuming your employee will quit unless he’s granted a wage increase?

Making an issue a priority is the best way to beat the risk of inaction. The fear of the perceived
outcomes or the fear of not knowing how to proceed gives us permission to keep urgent issues down
low on the priority list. But at what point does reality and rational reasoning take over so that we
recognize that the risk of inaction has more negative potential than that of any perceived outcome?
In retrospect, “inaction” is not so much a managed risk, but an unmanaged risk. Managing our
“inaction” actually reduces, or even eliminates, the risk.

If you struggle with inaction…
For a no charge consultation on where you are best to replace “fear” with “priority,” please call or email
me anytime.

life

Managed Risk – Part 3: Credit

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You’ve read how I am a fan of Seth Godin’s daily blog. His entry on Thursday September 17 was titled
Serving Size. He writes about how it is “our instinct to fill the bowl” with “bowl” being a metaphor that
could apply to anything and everything from our homes to our egos. For now, let’s consider the “bowl”
to be thought of as “debt.”

If you’re like most farm businesses, you’ve been getting a bigger debt bowl over the last 5-7 years. In
fact, I would bet that if you looked back at your statements from 2005, you would wonder how you even
managed to operate with such little debt (relative to what you’re carrying today.) This is not unique, and
considering western Canadian agriculture (especially grains) has been in a boom for the last 7 years or
so, it is of little surprise that debt levels have also increased.

The question then begs, “How big can the bowls get?”

Lenders love to see strong cash flow and increasing equity. Record cash receipts and appreciating land
values have bolstered lenders’ appetite to lend into agriculture. With money being as cheap as it is (low
interest rates,) farms’ debt bowls have been easy to grow.

What’s been filling all those bowls? Primarily it has been rapidly appreciating land and an insatiable
thirst for more and newer equipment. You’ve read here in the past that there is a distinct difference
between “good debt” and “bad debt.” I challenge everyone to evaluate what is in their “bowls” and
identify the “bad debt.” What percentage of your total debt could be considered “bad?”

Generally speaking, bad debt is the unnecessary debt. Often poorly structured, it eats up cash flow like a
game of Hungry-Hungry Hippos chomps marbles, and it uses up the finite space in your bowl. Yes, there
will come a time when a bigger bowl cannot be had, and it is then that many will wish they had managed
their credit a little closer.

We talked about interest rates in last week’s article, and it spawned more reader feedback than I’ve
received in a while (I’ll credit that to harvest being a greater focus than commenting back to me.) Gerry
Bourgeois, Scotiabank’s Director of Agriculture Banking for Saskatchewan & Manitoba, offered an
interesting strategy in his reader feedback: “With interest rates at an all-time low, farmers with a lot of
debt on their balance sheet should be taking advantage of these current rates to consider locking in 5, 7,
or even 10 year money.” Acknowledging that rates are still going to go up, even if it will be later than
many had expected, Bourgeois says, “I view the current low rates as a compressed spring. Once they
start moving up, they will move up quickly.” He goes on to suggest “locking in rates and using derivatives
to hedge interest rate risk” as a sound strategy many farms could consider.

“Similar to how a farmer would use commodity derivatives in a trading account to hedge his commodity
pricing, we use financial derivatives to hedge interest rates on larger transactions,” Bourgeois says.
Using what are called Banker’s Acceptances, he describes how a “swap” works as a hedge against rate
increases, and alternatively can even goes so far as to structure a “cap” on potential future interest rate
increases, functioning like interest rate increase insurance. “Utilizing these market instruments can
provide greater flexibility in your hedges down the road,” he concludes.

To put more emphasis on managing your credit, here are some focal points to get you started:

  1. Understand how your lender views your business. Are you seen as risky? Are you considered
    highly leveraged? (IE. Can you get a bigger bowl, and if not, is it right full?)
  2. Recognize how your cash flow matches up with your debt obligations? More specifically can you
    meet your debt obligations should your cash flow decrease?
  3. Eliminate bad debt, and keep it out of your operation. Just because you can afford the payments
    today doesn’t mean you should buy, and it certainly doesn’t mean you can afford the payments
    next year either.
  4. Look back at the worst year you’ve had profit wise in the last 10 years. How much debt could
    you service if that was your profit for the next 3 years? Let this be your guide.
  5. If your bowl is full, what is your strategy in case of an emergency (Eg. tractor needs an engine)
    or an opportunity (Eg. prime land unexpectedly hits the market)

Direct Questions

What are you doing to protect yourself from market changes? (Eg. interest rate moves, lender’s
adjustment to credit policy, etc.)

How can you strengthen your overall debt structure?

What happens if your lender instructs you to use a smaller bowl?

From the Home Quarter

Every business needs access to credit to facilitate growth. It is the reckless depletion of many farms’
credit capacity that will further heighten a potential cash flow crisis stemming from shrinking gross
margins. While we cannot change the decisions of the past, we can learn from them. And there is no
time like the present to take steps to improve your debt situation if it’s not currently ideal. There is no
time like the present to strengthen your credit structure to protect what you’ve built considering the
current lending environment.

There are many circumstances where it is a smart decision to get a bigger bowl, but it is often smartest
to know when the bowl is big enough, or even when to get a smaller one

horizon

Managed Risk Part 2 – Interest Rates

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In a conversation recently with a young farmer, who I feel is a poster boy for excellent business
management, he disclosed that he’s far more concerned with rising interest rates than low commodity
prices. During our brief exchange on this topic, I stuck with my position that interest rates, if they move
up at all, will see modest increases because when we consider the volume of credit currently
outstanding, the effect (desired or not) of any increases would be dramatically slower spending and
investment. Currently, I see no reason domestically to raise interest rates. His position involved a
number of macroeconomic factors including China, the US, and the EU. Admittedly, I’m less fluent in
how China’s recession will affect the Bank of Canada’s prime rate or how it will trickle down to Canadian
agriculture, specifically primary producers, but no doubt there is an impact to consider.

Just because the Bank of Canada may not be raising its prime rate does not mean that lenders won’t
raise theirs. The Bank of Canada prime and the chartered bank’s prime are related, but not directly
connected. The Bank of Canada makes its decisions on economic factors. Lenders make their decisions
based on business factors and their expectation of a profit. Lenders most likely recognize that increasing
rates now would be harmful, but again they have profit expectations and dividends to pay.

Is your business the same? Do you have a profit expectation and dividends to pay to shareholders?
It was encouraged in Growing Farm Profits Weekly #11 on March 17, 2015 for everyone to do an
interest rate sensitivity calculation. I would enjoy hearing from readers who did an interest rate
sensitivity to understand what they learned from the exercise. For those of you who didn’t do one, here
are some points to ponder:

  • Interest costs on term credits are controllable only at the time you sign documents, or at
    renewal.
  • History shows that over the long term, floating interest rates are cheaper than fixed rates.
  • While enjoying the consistency that fixed rates offer, consider the ramifications of renewing all
    your fixed rates at the same time. Having no control over, nor any idea of, what future interest
    rates will be, what is your strategy to manage this risk?
    HINT: it’s something you climb, but it isn’t a tree. Call or email if you want to explore further.
  • The interest rate you pay to your lender is a direct representation of 2 factors:
    • The cost incurred by the lender to acquire the funds being lent to you, and
    • Your lender’s view of how risky your particular business is. IE: you might pay more or less interest
      than your neighbor if the lender views your farm as being more or less risky than your neighbor’s farm.
      (This is the significance of knowing what’s important to your lender!)
  • Competition for business is the 3rd factor affecting your interest rate – and it goes both ways.

At the end of the day, your control is over how much you borrow, and for what purpose. Bad debt is
unhealthy enough, but interest on bad debt is worse. Your interest strategy needs a blend of fixed and
floating rates, varying terms, and payment dates that align with your cash flow.

Direct Questions

Consider the pros and cons for each of “blended payments” and “fixed principal plus interest
payments.” Which payment structure best fits your needs?

When doing an interest rate sensitivity test, do the results scare your socks off?

What is your strategy for managing loan interest?

From the Home Quarter

The great equalizer across all farms is Mother Nature. What isn’t equal is how each farm manages risk.
Those who are averse to any debt often miss out on growth opportunities. Those who have a flippant
approach to debt often find themselves painted into a corner. It is a strategic and measured approach to
managing risk that sets apart the players in the game.

farm

Managed Risk Part 1: Harvest Sales

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In an email last week, a farmer friend and former colleague of mine admitted to having 100% of his 2015 crop sold before harvest. It is the first time this has ever happened on his farm. From my years working in ag finance and farm management consulting, I can confidently say that virtually all farms are not 100% sold on new crop in advance of harvest.

As with anything, there are benefits and drawbacks to being 100% sold early in the crop season. It’s easy to identify the drawbacks: production risk (broken into yield risk and quality risk), opportunity risk (if the market appreciates after you’re sold), etc. etc. We’re not going to dwell on these because it’s safe to say almost every farmer has already spent more than enough time hashing and rehashing all the reasons why they shouldn’t sell too early. There are far more drawbacks that have been touted over the years (real, perceived, or otherwise) than I care to scribe. You’ll notice I didn’t put weather risk on the list; it is because we cannot influence or control weather. Why stress over that which you cannot control?

How about some of the benefits:

  • Reduced delivery risk
  • Eliminated market risk
  • Reduced storage risk
  • Controlled cash flow risk

When admitting his crop was 100% sold already, my friend and I didn’t get into the details of what was in place so that he felt comfortable making such a decision. He did acknowledge that prior to harvest the prices were too good to pass up. While price is an important factor, price alone is not sufficient to pull this trigger. Here’s more on what you need if you want to be a more aggressive price maker, instead of a passive price taker.

  1. Excellent relationship with your buyers.
    When it comes to dealing with quality and grading, delivery times, or anything in between, a solid relationship with the buyer of your grain is crucial. Try using a sense of entitlement when next dealing with your buyers and see how far you get. This one is obvious; we won’t dedicate any more space describing what you already know.
  2. Know your costs, especially Unit Cost of Production. As one of my favorite young farmers likes to say, “You can’t go broke by selling for a profit.” Such true words require that you know what it cost to produce a bushel or a tonne so that the price you accept is actually profitable. This isn’t an easy task before harvest, but those farms that have elevated management functions can clearly illustrate UnitCOP with allowances for deviation in expected yield or quality. Refer back to point #1 when dealing with those deviations.
  3. Abundant Working Capital.
    Any drawback, real or perceived, to selling most of your crop ahead of harvest is mitigated by having abundant working capital.
    The biggest selling benefit from having abundant working capital is being able to sell when you WANT to instead of when you HAVE to. The ability to sell on your own timeline affords you the opportunity to deliver in your preferred month, and to seek out your preferred price. Abundant working capital also alleviates the fear of costs incurred from not meeting contract requirements when aggressively forward selling. The hesitation felt from the potential of having to “buy out” a contract if specs aren’t met can be eliminated if working capital is abundant.

It is not unreasonable to see more reluctance this year among durum growers to forward price as aggressively as in the past. The fusarium fiasco of 2014 hurt numerous farms financially and created an air of hesitation. But if working capital was a non-issue on every farm, durum growers would not be shy to forward price after the 2014 experience. While none want to set themselves up for unnecessary cost incurrence, the ability to handle the potential cost alleviates the concern of incurring it.

Direct Questions

How would you rate your relationship with your grain buyers? What can be done to improve it?
How would you describe your knowledge of your Unit Cost of Production, and net profit margin?
What is your current level of working capital and what does it need to be to provide you with full confidence to aggressively forward price?

From the Home Quarter

Please let it be clear that this message is not encouraging everyone to sell 100% of new crop production ahead of harvest. Such a strategy takes on risks that not every farm can mitigate. But if you are desirous in forward pricing more new crop than you have in past years, then let this message offer you some tips on what you need to have in place to make that happen.
You may have noticed that working capital is a central theme to many messages delivered here weekly. If you are able to focus on only one priority, let it be working capital.
Our proprietary Farm Profit Improvement Program™ begins with working capital evaluations and True Cost of Production analysis. Please call or email to learn how this process can bring value to your farm.