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- DTN Headline News
By the Numbers
Wednesday, March 22, 2017 6:29AM CDT

By Danny Klinefelter
DTN Farm Business Adviser

I recently attended a Farm Credit Director Development program in Charleston, South Carolina, where Dave Kohl presented an agricultural economic update. I thought his presentation was exceptional.

He described agricultural producers as fitting into one of three categories: 1) still profitable and cash flowing, still managing tighter margins; 2) those with low leverage ratios, but facing declining working capital and being forced to refinance; and 3) zombies -- those still managing the business pretty much as they always have, but being forced to sell property, digging into core equity, and experiencing multiple refinancing.

He also noted that large borrowers were falling into two categories: 1) those that were still profitable because they got where they are because they were better business managers, and 2) those that were beginning to face severe financial problems because they had gotten bigger before they got better during the boom period that ended three years ago.

He pointed out that producers in the latter two categories in group one and the last category of large borrowers in group two tended to exhibit several characteristics:

1. They were using out-of-date methods of preparing and analyzing financial information;

2. Didn't know their true cost of production by enterprise or individual farm units;

3. Weren't controlling family living costs;

4. Hadn't shed non-productive or non-economical assets;

5. Didn't have a written improvement plan;

6. Didn't practice the four cornerstones of business success -- plan, strategize, execute and monitor;

7. Didn't have or execute a marketing plan;

8. Didn't have a good handle on record keeping;

9. Didn't "sweat the small stuff" and weren't employing the 5% rule I've been stressing for the last 25 years; and,

10. Have not focused on developing or preparing for the next generation.

All of this makes it clear to me that unless lenders and Extension immediately begin educating borrowers about finance and the basics of management, the situation could get really ugly if this downturn in the ag economy extends for another three years as many are predicting.

While USDA's Farm Service Agency still has the borrower education requirements they instituted several years ago, most commercial lenders have shied away from requiring training and have only made it available for young and beginning farmers and established farmers who recognized they need it and sought it out. If FSA required farmers to go through training, they believe many/most of their borrowers would not be motivated to learn and apply what they heard, or if they did, those borrowers who could would leave and move to another lender.

Extension has been hampered by several things. Budget cuts have seriously cut into the number of financial specialists in many states. Even if Extension did offer in-depth training workshops, participation would be minimal. Most farmers fall into one or more of four categories:

1. They don't recognize what they don't know;

2. They don't like to work with numbers or other areas where they have a weakness;

3. They don't think they need it; or,

4. They are too embarrassed and fear it would stigmatize them because it would indicate to others that they have a problem.

If the training did occur, there are several things I believe definitely need to be covered in a workshop format, i.e., so participants have to work through exercises and not just listen:

1. The mechanics for adjusting cash to accrual net income and why it's critical.

2. How to calculate both earned and market value need worth and why it's important.

3. How to calculate the working capital burn rate.

4. How to calculate the equity capital burn rate.

5. The calculation and interpretation of the key financial ratios.

6. How to calculate and interpret the DuPont model so producers can determine where the real problems lie and where changes would generate the biggest benefit.

7. How to calculate actual family living withdrawals.

8. The importance of developing "what if" scenarios and strategies to dealing with events proactively.

9. The importance of monitoring actual versus plan performance on a regular basis throughout the year and focus on the variances so producers can address problems and opportunities in a timelier manner.

10. The need for farmers to be moving toward cost/managerial accounting so they know their costs at a farm, enterprise, and unit of production level.

11. Finally, understand the 5% rule and how a 5% increase in production, a decrease in costs and a 5% increase in net price received can affect the bottom line by over 100%, plus the addition to earned net worth can be compounded over time.

One approach might be to offer borrowers an incentive, such as a rate reduction, if they participated in a meaningful way and demonstrated that they learned and were adopting what they learned.

Unless something dramatically changes, I'm afraid we could be headed for a repeat of what happened in the 1980s. It probably won't be as severe, because there have been some significant changes; but, it could still be disastrous in some regions of the country.

There are tools available now that were not there in the 1980s. The Farm Financial Standards Council has financial reporting and analysis guidelines that didn't exist. Many state Extension services did develop educational materials following the financial crisis that could be resurrected and updated with current information. Also, lenders like Ag Choice Farm Credit Services are using the modules developed by Dave Kohl in their Ag Biz Planner Program that could be used by other lenders. This might even be a place where Farm Credit, commercial banks, and Extension could collaborate for the good of the farm community.

Something needs to be done soon, before it's too late for many farmers and many ag lenders, as well.

**

Editor's Note: Danny Klinefelter is an agricultural finance professor and economist with Texas AgriLIFE Extension and Texas A&M University. He also is the founder of the mid-career Texas A&M management course for executive farmers called TEPAP. To read all of Klinefelter's recent DTN columns go to https://www.dtnpf.com/….

(AG/ES)


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