Complacency: The Silent Financial Killer
By Dr. David Kohl
In a world that seems to be so unpredictable, what is wrong is that it is so predictable. This was a quote from a number of years ago in The Atlantic magazine and was reinforced by the famous astronomer, Carl Sagan. He was a professor while I was a student at Cornell University and occasionally dropping in on his classes was an unforgettable, futuristic experience.
The current economic environment is similar to what we have seen and experienced before, particularly in the late 1970s. Human behavior is very predictable. Let’s apply this concept of predictability to the agriculture industry. Current high land values, commodity prices, and generous government payments have created complacency when it comes to the basics. Believe it or not, history books will document that similar neglect was apparent in the past as well.
Evidence surfaced in a recent producer meeting that complacency is alive and well. I asked a room full of participants how many were developing monthly and quarterly cash flows to aid in decision-making in these volatile times. All I could hear were crickets, except for one young couple who reluctantly raised their hands. In response, I flashed back and went into full basketball coaching mode and proceeded to scold but challenge them that this management behavior would not succeed in the upcoming years. My evaluations probably suffered, but I did solicit a response. What should be tested in today's world where predictable is unpredictable?
Financial Scenario Testing
A good set of financial spreadsheets with assumptions on changes in prices, production, cost, and now interest rates can bring objectivity to an economic environment in which one must get comfortable with the uncomfortable. The producers, who were now engaged, then asked, “What are some of the financial sensitivity tests that we should analyze in the farm and ranch business?”
First, analyze various levels of production by enterprise. This is where one could draw on crop production data, trend analysis, and historical factors that create both positive and negative deviations.
The next test would be to analyze various price points. Depending on the commodities, one would have to examine marketing contracts, forward pricing, or marketing option plans. In this financial sensitivity analysis, incorporate various levels of crop insurance that may cover possible negative outcomes due to weather, disease, or other Murphy's Law's effects. In the pricing factors, the value of the dollar may be considered both on the output and the input side and how it may influence profit margins. Again, factor in the strengths of the economy, both domestically and globally, now that it appears that a possible recession will influence buying power.
On the expense or cost side, analyze input costs at different levels of inflation and how it influences breakeven points in marketing strategies. In 2023, analyzing and preparing for the availability and potential prices of key inputs such as fertilizer, chemicals, fuel, and energy is essential in scenario planning. A deeper critical analysis may be conducted on the availability and how the continued supply and marketing chain disruptions will require plans A, B, and C.
Central Banks and Interest Rates
The U.S. Federal Reserve has made inflation its public enemy number one. This is where you must examine your debt structure and terms. Is your debt on a fixed or variable interest rate? Are some of your loans on a five- or ten-year reset, or are interest rates fixed over the life of the loan? The question then becomes how much of a financial shock test needs to be conducted? Given the current and possible future levels of inflation, a 1 percent to possibly 4 percent increase in interest rates might be in store in the short run. Determine how this influences your ability to service debt and its impact on the term debt and lease coverage ratio.
This type of analysis can establish financial guardrails that can keep your business out of the cash flow ditch. The real benefit is that it can be used as a discussion point in financial and business management meetings with stakeholders and advisory groups. It is also very useful in establishing the outer limits of lines of credit with your lender.
To be very blunt, the generous government payments and increasing land values have made some producers very complacent in financial, marketing, and risk management decisions. A case in point is an East Coast producer who recently said, “I'm not worried about a formal financial plan because the government will take care of me!” This type of attitude places the odds of failure at a higher probability.
Managing in today’s economy is analogous to a basketball team getting ready for the tough part of the schedule. Planning, developing strategies, executing, and monitoring outcomes given different scenarios can be a powerful management tool. The future is bright for those who do this type of analysis; however, the future is full of financial trap doors for those who do not have a plan for adversity.