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Over the last five years, grain farming has been very profitable. Higher grain prices led to higher profits, resulting in producers reinvesting heavily in their operations. This has caused the fixed costs of farms to increase significantly.
We’ve witnessed two common outcomes of this reinvestment. First, higher debt levels are taken on by farm managers. The new debt results from the purchase of new assets such as land, buildings, and equipment that are financed instead of bought for cash. Financial Institutions have been eager to lend money into the profitable grain sector. Lastly, producers face higher land rental costs as the demand for productive land increases in times of high prices.
Prices have been strong over the previous five years, but have dropped significantly this fall and continue to decline with an outlook of a very large crop in the United States, leaving producers to question if this is the beginning of a shift towards low prices in the coming years. While grain prices and margins in western Canada have been good, depending on the localized yield, producers may now need to re-evaluate their operations to protect their competitiveness in a time of falling prices.
One of the advantages of grain farming is having one production cycle a year. Operations have the ability to adjust before the next production cycle starts. The time between harvest and the start-up of the next production cycle in the spring provides six months of operational analysis. Producers can evaluate their operations and make adjustments to become more efficient. Other industries face much shorter production and adjustment cycles, such as the hog industry, where they produce and sell every month, and shifts in prices can dramatically and quickly affect their bottom line. As producers face a potential price decrease, some steps can be taken to minimize future risk:
1) Begin by reviewing your operation’s cash flow given today’s prices. Does the farm generate enough cash and have enough operating credit to put in next year’s crop?
2) Evaluate long-term commitments. Land or equipment rental arrangements that are priced to reflect the previously high prices may require re-evaluation now that prices are on a downward trend.
3) Does the farm have the ability to service debt today and into the future? For some operations, lowering fixed costs will be necessary to ensure profit.
4) Do you need to restructure your farm finances? Some operations won’t be able to sustain their current payment levels with lower profit margins. Lengthening loan amortization allows the farm to conserve cash and carry an operation through several cycles of decreased prices and profits.
Ultimately, producers must determine if they can afford to operate during a time of lower prices. Mitigating the risk by making necessary adjustments to their operations can help them weather the price dip
This article was originally published in the Western Producer in September 2014.
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