Managing Financial Risk During a Boom Period

Managing Financial Risk During a Boom Period

March 28, 2008

 

It's much easier to restructure debt during boom times than bust times.

Agricultural profits have historically been cyclical. In the current "boom" economic times of high profits, opportunities exist to favorably improve your operation's liquidity — the availability of cash or the availability of assets that can quickly and easily be turned into cash. The higher the liquidity of the business, the easier it is to meet cash flow needs and to take advantage of unexpected buying opportunities.

Restructuring Credit

One strategy is to take advantage of high real estate values (without selling or renting out one's land) to restructure the farm's credit needs from short-term debt to long-term debt. How individual farm debt is structured can greatly impact how your operation weathers low-profit or even no-profit years. Most areas of Nebraska are experiencing record or near record high real estate values, thus creating an increase in the collateral for a long-termloan.

See entire Cornhusker Economics article (PDF 138KB), for details, including examples from several farm operations.
If you're looking to lock in a better interest rate for a long-term loan, be sure to check out a lending source that understands your operation and does not charge a pre-payment penalty fee. If interest rates drop lower or good times create extra cash, you may want to reduce your borrowing needs by paying extra principal; a pre-payment fee will hinder your financial planning.

Measuring Your Liquidity

Two options exist to measure liquidity. In the first case, liquidity is measured by working capital (Current Assets minus Current Liabilities). In the second, liquidity is measured by current ratio (Current Assets divided by Current Liabilities). Depending on how you structure your short-term and/or long-term debt, a lower interest rate with a longer repayment period could be beneficial to short-term, cash flow issues.

Disciplined Spending

Although embarking on a long-term debt plan like this can help to reduce some financial risks by increasing liquidity and improving cash flow operations, it also requires personal spending discipline to only use the newly available cash for sound business practices. Buying new paint you really don't need or embracing sloppier management now that the pressure's off could expose you to more risks than a tight cash flow and high interest rate. Good overall management is still critical to success.

Remember, it's much easier to restructure debt during boom times than bust times. Restructuring debt during good times may enable your farm or ranch operation to more easily adapt and stay profitable through the bad times that most certainly will appear again someday.

Dave Goeller
February 6, 2008 Cornhusker Economics