As Dr. David Kohl said at our Water Street Edge farm business seminars this winter, it's often the 'black swan' type of event – something unexpected that comes out of nowhere – that can have a major impact on your operation.
No farm can be completely prepared for these game-changing events, but one way you can be more proactive is by stress testing your business. I'll be digging into that this week and next week in this blog.
What would a banker think of this farmer? The farmer brings in financial scenarios of a couple different potential risks that could affect his operation in the next year, and says, 'Here's what I foresee could be the potential pitfalls this year, and here's how I plan to deal with them if they occur.' Wouldn't that impress that banker?
One area to set up a stress test for your operation is around interest rates. Depending on how your operation's debt is structured right now, a change in interest rates might affect you a little, or a lot. Use a stress test to determine how your farm's financials could be affected if interest rates were to move upward.
If you have fixed rate loans and don't carry anything on your operating note, then you wouldn't be greatly affected. But if you have variable rate notes or a lot on your operating line over much of the year, the stress test will probably show that a rise in interest rates could create some issues for your operation. Knowing the potential impact is the first step to creating a plan for how you would deal proactively with it.
What can you can work on
Have you ever asked your banker how the bank is currently rating your operation? Your operation's risk rating is tied to the line of credit that the bank is willing to extend to you. So, it's beneficial to you to know if there are areas where you can work to improve it.
You might have a conversation with your banker and explain that you're working to improve your operation. You'd like to understand the most important factor you could work on – to potentially be able to get a better interest rate on your line of credit.
Then, commit to working on what the banker tells you. For example, maybe it's increasing your liquidity. That gives you the chance to focus on increasing your working capital. Maybe you make some different decisions because of that focus.
Ultimately, it's all positive for you – you're getting advice to help improve your operation and you might improve your risk rating with the bank, maybe getting a better interest rate.
In next week's post, I'll explore a few more areas you may want to 'stress test' in your business – for your own knowledge and for the opportunity to be proactive about it with your lender. In the meantime, check out articles on efficiency, innovation, and farm transition planning in our quarterly publication, Smart Series.
The opinions of Darren Frye are not necessarily those of Farm Futures or the Penton Farm Progress Group.