This is the first in a series of articles on risk management - a topic that's increasingly important today as many farmers have less net worth per acre. My father, for example, farmed 640 acres and had a net worth of roughly $600,000, or about $940 net worth/acre. He survived for 40 years of farming, but in a less volatile environment. To have a comparable risk-bearing equity today, someone farming 2,500 acres would need a $2.35 million net worth.
With changes in global competition, government policy and technology, price fluctuations are wider and more dramatic than ever before. That's why I believe risk management will be the most important task for farmers to learn and use in the years ahead.
Risk management is everything you do that impacts the long-term growth of your net worth. It includes marketing plans and decisions, but goes far beyond how you sell your grain.
Our basic approach to risk management is to protect the downside so you don't lose money (or go broke) and have the topside open to take advantage of market gains or cost decreases - if they occur. This is important because none of us knows what grain prices or costs will do in the future. For example, in our weekly communication to our customers on Mar. 20 last year, we recommended booking diesel fuel needs for the year. We had clients who did that for 52cents/gallon off the tank wagon. Those who didn't paid much higher prices at harvest.
There are two ways to impact your bottom line. They are income and costs, and both need to be managed.
Of the risk management plans I've developed for our customers the past year, the largest area of variance in breakevens is the difference in machinery and equipment investment per acre.
Most farmers pay about the same for seed, fertilizer, chemicals, rent, etc. But the equipment investment per acre for our customers varies from $131 to $313. That's a 140% difference. The annual cost of ownership is generally 25% of that cost (10% interest, 10% depreciation and 5% repairs). This can make a $46 per acre difference between the high and low. In many years, that's your profit.
In summary, good risk management involves having good records, knowing your breakevens, having a good crop insurance program coupled with an option strategy and making good investment decisions. Each is a critical component and together they make good risk management. Each could be done well individually. But if not treated as part of an overall program with a plan, they will not keep you in business. We'll discuss each of these in upcoming columns. ??
Moe Russell is president of Russell Consulting Group, Panora, IA. Russell previously spent 26 years with Farm Credit Services as a division president. For more risk management tips, check out his Web site at www.russellconsulting.net.