$potlight on Economic$
Economic Stress Testing Your Farm
By Ryan Larsen
(Editor’s Note: Ryan Larsen is an Assistant Professor in the NDSU Agribusiness and Applied Economics Department.)
As a high school student, like many farm kids, I signed up for as many welding classes as I could. I enjoyed the satisfaction of joining two separate pieces of metal and having them be as strong as one.
Each semester, we would take one of our welds to a local technical college to have them stress tested. The college staff would put the welds in a large hydraulic press. They would bend the metal until the welds were bent in half or broke. The student whose weld could withstand the highest pressure would win the competition.
I often think of those pieces of metal bending under the pressure of that hydraulic press. Some welds looked fine on the surface but would break with just a small amount of pressure. Other welds that had adequately bonded with the metal couldn’t be broken.
Just like those pieces of metal, farmers are consistently under pressure. Farmers have experienced high demand and prices for their crops the past few years. However, farmers and experts agree that these conditions cannot be sustained forever. I wish I had a crystal ball to forecast the exact day when those conditions will change, but I do not. When market conditions do change, farmers are going to be exposed to “stress tests” of their farm. The key is that these situations may force them to bend but never break.
I have seen scenarios of farms that have broken and farms that have survived the pressure of tough farming conditions. I would like to provide some observations from both sides.
One of the keys to not breaking is to rely on the relationships you have developed with input suppliers, lenders, insurance agents, commodity brokers, elevators and last, but not least, family members. The importance of establishing strong working relationships with each of these cannot be understated.
For example, a lender can help you develop a series of stress tests for your farm. The tests could consist of doing some simple “what if” analysis to determine the impact on your projected financial statements. The possible what if scenarios could be a drop in production or price, an increase in interest rates or all of the above.
A lender will point out areas of concern and work with you to strengthen these areas to ultimately make you financially stronger. It is a lot easier to have these conversations when times are good than after you have waited too long and times are rough.
The increase in price volatility also has increased the importance of a sound marketing plan. Part of this marketing plan is working with a commodity broker or elevator to market your crops. Clear communication of the marketing plan will ensure that all parties are on the same page and working toward the same goals. In addition, communicating your marketing plan to your lender will demonstrate your commitment to implementing a sound risk management strategy.
Lastly, building a strong relationship with family members is vital. I have seen farming operations that I thought were unbreakable but were destroyed by poor family relations. Clear communication of goals, responsibilities and expectations will help everyone be on the same page. The importance of strong communication grows exponentially if there are multiple families involved in the operation.
Building strong relationships is just one key to weathering tough times. Frayne Olson, NDSU Extension Crops Economist/Marketing Specialist, and I are working on a project to develop a series of stress tests for North Dakota farms. These are data-driven tests that are based on statistical methods. The tests will provide another method for farmers and their lenders to evaluate the strength of their operations.