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Global trade risk, part 2: What actions can farmers take

The last column focused on global trade risk as one of the biggest risks in many segments of agriculture. Yes, political and military risks have played out in Russia with Mr. Putin limiting exports to that country. Central bank strategy in the U.S., Europe, Japan, and China has recently strengthened the dollar, which may impact U.S. agricultural producers for the long haul.

Now that being said, what actions can a producer take? First, when projecting cash flows, scenario planning will be a requirement. Financial and economic shock tests on prices and costs are critical. In one of my old books, Weighing the Variables, I wrote about how “but what if” sensitivity analysis of a 5% decline in revenue and a 5% increase in costs would be sufficient. In today’s global environment, testing for effects of a 10% or 20% decline in prices and increase in costs cannot be dismissed. As a case in point, the dairy industry exports one in seven days worth of milk. Producers have seen how slowing emerging nations’ economies combined with a strong dollar have reduced milk prices by over 25 percent in the past three months. Of course, eight dollar corn and soybeans in the high teens have experienced similarly steep price declines also.

It is imperative in today’s world of trade risk to build up extra liquidity or working capital reserves. How much is enough depends on debt servicing requirements, and marketing and risk management plans including crop insurance. A modestly leveraged agriculture producer with a debt to asset ratio below 40%, with a solid marketing and risk management plan could have a working capital to revenue ratio of 30% as a goal. However, a producer who is highly leveraged, with a debt to asset ratio above 50% and no marketing or risk management plan, should plan to keep working capital to revenue of 40% or higher.

Finally, do not bet the farm’s fortune or future on global trade. Global markets can be given or taken away, as any global trader would confirm. The key strategy is to have plenty of stretch in the financial and economic waistbands to manage through abrupt cycles created by global trade.

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