Field Notes Blog > Misdirected Decisions

  • Misdirected Decisions

    December 01, 2017

    Featured Guest Writer: Dr. David Kohl 

    The current, elongated economic reset has placed many farms and ranches in the reassessment phase of the business cycle. Some producers are taking proactive strategies to correct the course. However, other producers are using strategies that will misdirect their decisions. Let’s examine a few of these deceptive approaches.

    Single focus on production
    In some locations of the country, producers have been in a garden spot environment, boasting ideal weather and record yields. If repeated over a few years, these conditions lure producers into the belief that they can grow their way out of any financial woe. Yes, production is critical. And regardless of the price point, additional yield is always helpful to the bottom line. However, the old economic principle of the marginal cost and marginal revenue equation must be met. Whether it is crops, livestock or any production aspect of agriculture, marginal revenue must exceed marginal cost.

    Counting on Mother Nature
    Some producers are holding out for an adverse weather event elsewhere in the world to return better prices. Without a doubt, there will be some adverse event, weather or otherwise, to trigger such a price shock. But waiting for these events without making the necessary tweaks and adjustments in the business is an impractical strategy based on wishful thinking. Additionally, such a price shock will be temporary.

    Balance sheet invincibility
    I have encountered some producers that believe their equity and balance sheet worth make them financially invincible. In short, they become complacent to the financial realities of the business. Some might say, “I have considerable equity on the balance sheet, and farmland is still going up in value. I have nothing to worry about.” This can be a losing strategy that delays the actions required to bring the business back to profitability. To compound the issue, the younger generation can easily learn and adopt this same approach. Of course, this is where the saying, “The first generation makes it, second generation holds it, and the third generation loses it” comes from. In almost every area of life, complacency is a killer.

    Expand out of the problems
    It is a common strategy to grow the business when facing financial adversity. However, if one has to lose money in order to expand, the bottom line losses will only accelerate. Remember the old adage, “Better is better before bigger is better.”

    The cost-cutting gamble
    Be careful of which costs you cut. For example, cutting back on livestock feed may improve the short term financial picture, however, it may sacrifice longer term sustainability. According to farm record systems, farms in the top sector of profitability are spending less on fertilizer, and also increasing yields. This suggests increased efficiency in resources. Yet, a blanket decrease in fertilizer usage is another example where long run profitability may be jeopardized. So, before cutting crop insurance, consider a worst-case scenario without it, as you should before deciding on any expense adjustments.

    From my travels coast to coast, these are some of the misdirected strategies I have seen and heard from producers, lenders and others in the agriculture industry. So, as you fight the good economic fight, don’t get caught in a trap!

    Comments

    Please send your remarks to BMC@northwestfcs.com. I would like to know what you are thinking.

    Dr. Kohl is Professor Emeritus of Agricultural Finance and Small Business Management and Entrepreneurship in the Department of Agricultural and Applied Economics at Virginia Polytechnic Institute and State University. Dr. Kohl has traveled over 8 million miles throughout his professional career and has conducted more than 6,000 workshops and seminars for agricultural groups such as bankers, Farm Credit, FSA, and regulators, as well as producer and agribusiness groups. He has published four books and over 1,300 articles on financial and business-related topics in journals, extension, and other popular publications.

    © Northwest Farm Credit Services 2017

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