Financial risk in your ranch operation has a myriad of aspects, but it begins when your business borrows money and creates obligations to repay debt. Notably, in today’s environment of higher inflation and rising interest rates, accurate accounting and clear account management strategies are important to ensure that you don’t overextend your capital debts to the point of insolvency.
This guide, assembled by Redd Summit Advisors, is the final in a five-part series aimed at helping you identify risks and formulate strategies to operate a successful livestock operation. Read on for more details about managing your financial risk, and be sure to bookmark our blog to stay informed. To see the previous installments of this series, click here.
Understanding the Aspects of Financial Risk Management
Access to capital
The ability to access agricultural loans is vital to many ranch operations, but it adds risk in the sense that one difficult production year could disrupt cash flow to the point that a loan obligation cannot be paid back. In addition, the willingness of a lender to extend credit can change continuously depending on interest rates and security requirements.
Capacity to withstand short-term financial shocks
Agriculture is an industry directly impacted by weather and natural disasters, which makes it more volatile overall. Because of this, maintaining adequate insurance and having cash on hand can go a long way in the event of drought, disease, legal issues, or a personal crisis.
Managing cash flow needs
Because commodity prices and your operation’s production levels are always subject to change, having an accurate handle on your monthly cash flow needs plays a major role in how you mitigate unexpected encumbrances.
Ability to maintain and grow equity
The goal of every operation should be to increase net worth over time. If you’re only able to cover annual operating loans and make a personal draw for living expenses, then you’re not making a profit or increasing your equity. Additionally, opportunities for obtaining credit will suffer if you can’t eventually show a positive return.
How to Mitigate Risk Involved with Your Ranch Operation’s Finances
You have a lot of tools available to assist you in handling your risk and making your operation more profitable. The tools you use really depend on your individual situation and your risk tolerance level.
Keep good records
Maintaining up-to-date, accurate financial records helps you understand your unique risks and helps you determine what steps you need to take in order to improve your financial picture. Always keep a current balance sheet, know your debt-to-asset ratio, and understand your cash flow situation.
Maintain cash and liquid reserves
A sudden financial hardship can be managed effectively by using cash kept in reserve or accessing revolving lines of credit. In the case of credit, maintaining a high credit score and having credit lines open well ahead of difficult times will ensure you have consistent access to cash.
Utilize LRP or PRF insurance
The production risks in ranching often revolve around drought, lack of forage resources, or market price fluctuations. That’s why securing Livestock Risk Protection (LRP) insurance or Pasture, Rangeland and Forage (PRF) insurance can help you obtain indemnity payments on declines in market prices for cattle or lack of rainfall in your geographic area, respectively.
Work with a reputable lender
Choosing an agricultural lender who you feel comfortable with and who has active interest and expertise in your type of operation can sometimes make the difference between your operation losing or gaining equity. Make sure your working relationship is constructive and that your lender supports your overall goals.
Part V of this risk management guide helps you identify what financial risks you may have with your livestock operation and how to manage them effectively. Watch our Redd Summit blog for more posts about risk management and contact us at 1-800-825-2355 to learn more about our Pasture, Rangeland, and Forage (PRF) insurance and Livestock Risk Protection (LRP) insurance.