The Importance of Farm Budgeting & Risk Management
December 23rd, 2020
Farmers are important for both domestic food production and food exports that contribute to the global economy, but farming can be an unpredictable business. The agricultural industry can be volatile, and issues with crops, drought, disease, changes in market prices, and destructive weather can wreak havoc on your finances.
But not if you’re prepared. By keeping a close eye on your farm’s budget and taking steps to manage risk, you can be ready for the unexpected, and ensure your operations are not affected by the volatile nature of agribusiness. Let’s discuss some farm budgeting and management strategies now, and give you insights on the steps you can take to create a more resilient farm or ranch.
The 3 Most Powerful Financial Tools for Farm Budgeting
Just as with any other business, the best way to make sure you’re profiting and manage risk is to have a clear idea of how profitable your business is, as well as your current assets and expected future cash flows. There are 3 essential documents needed for farm budgeting:
- Profit and loss statements — These record your income and expenses, and are usually recorded quarterly or annually. Your profit and loss evaluation helps provide insight on operational costs, ROI (return on investment), growth or decline in profit margins, and more. It also helps you determine how much cash you have on-hand to pay taxes, purchase assets, and pay down debt.
- Balance sheets — A balance sheet lists the value of your operational assets (buildings, farm equipment, etc.) as well as your current liabilities (debts) and net worth, including cash.
A balance sheet can be generated monthly or annually, but maintaining the sheet at a shorter interval helps make it more manageable. If preparing a yearly balance sheet, do so at the same time each year to ensure the information can be used for comparative analysis.
- Statement of cash flows — This includes income from sales, investments, ad hoc payments, and any other income relevant to your farm, as well as expenses related to farm labor, input costs like fertilizer and seeds, equipment investments, loan payments, land purchases, and other costs.
Essentially, this document outlines how much you’re making and how much you’re spending, and ensures you’re managing your cash income in a sustainable way. This helps you document your farm’s margins and develop future goals for your operation.
Risk Management for Farmers — How to Safeguard Profits
Farm budgeting can help you develop a more informed risk management strategy. There are a few ways to reduce risk in your operation — here are a few popular methods.
- Market intelligence — This means being aware of factors affecting the market for particular crops or agricultural products, and understanding trends within the industry. This information can be used to make better decisions and maximize value within your farm.
- Hedging and diversification — Many farmers “hedge” against losses by taking out crop insurance. If crops fail, their risk is reduced because they can still be compensated for a percentage of the crop’s value. Diversification, such as planting multiple types of crops or raising many different types of animals, can also help yield better long-term returns and minimize risk.
- Forward contracting — This involves locking in the price for a particular harvest in advance. Basically, you choose an agreed-upon price in advance, and when you sell your crop in the future, that’s the price you get, no matter what the current market value of your crops is. This can help protect you against price volatility, get a predictable return on your investment, and minimize the risk of crop waste.
Community West Bank is here to Help Agricultural Businesses
At Community West Bank, we specialize in Farmer Mac ag loans for farmers, ranchers, and other agribusinesses. If you need to expand your operations or invest in the future of your farm or ranch, we’re here to help. Contact Laura Maffei to get started. Call her at (805) 692 - 4394 or (209) 679 — 9244, or send an email to LMaffei@CommunityWestBank.com.