|Financial Risk Management|
planning and financial
control are the keys to managing financial risk. The Risk Management
Agency (RMA) identifies financial risk as three basic components for the
agricultural business. They include:
Let’s look at these three components.
It is important to recognize the different purposes and structure of debt capital.
Operating Debt– This type of debt helps a business manage its cash flow. This debt will provide the necessary capital to a business during the seasonal cash flow valleys when expenses exceed income.
Capital Debt– This type of debt provides the funding for capital investment. Capital investment includes machinery/equipment, leasehold improvements and expansion funding.
Long Term Debt– This type of debt provides the funding for long term investments like real estate. The business owner must secure a least cost loan that meets the return requirements of the investment and meet the profitability and cash flow needs of the business.
It is equally important to develop a good relationship with your primary lender who understands your business plans so that you have access to debt capital when needed. Business growth is impeded when debt is not available at the right times. Too much debt will place a significant burden on the business so debt management is a critical management component. Without proper analysis, structuring and planning, debt capital can lead to complications and risks that could become unmanageable.
The ability to meet cash-flow needs in a timely manner - Cash-flow management is a critical element for all businesses and particularly for agricultural seasonal businesses. There are many months of the year where expenses will exceed income. The business owner should identify funding needs on a month to month basis. This will determine funding needs and timing.
The ability to maintain and grow equity- This is the ultimate objective of any agricultural enterprise because without maintaining equity the business would become insolvent. Without growing equity the business will not keep ahead of inflation. Eventually this leads to insolvency because inflation will reduce the value of the equity in the business in the long term. There are many management considerations when discussing the ability to grow and maintain equity. A key element is sufficient sustainable annual accrual and cash profits.
The required profit level is different for each business. When determining sufficient profitability many factors come into play. For example; family living expense, capital reinvestment requirements, term debt payment requirements, return on investment requirements set by management.
There are many tools available for a business owner to manage growth. They include but are not limited to budgets, proformas, monitoring systems and business plans. All are critical for the long term success of any business and all involve planning.
David Kohl, a professor of agricultural economics at Virginia Tech, in a published study reported that planning is a critical process for the farmer that very few go through formally. However, there are some very real benefits that accrue to those who do;
Plus, good management, which includes planning, is the single most important factor separating profitable and less than profitable businesses today.
The business owners that can employ good financial risk management strategies are the entrepreneurs who will succeed in the competitive agricultural industry.