COLLEGE STATION – A risk management program helping producers make sound financial planning decisions is also serving as an aid during periods of drought, economists with the Texas Agricultural Extension Service say.
The Financial and Risk Management (FARM) Assistance program is a financial planning tool aimed at helping both farmers and ranchers become better managers and marketers, said Joe Outlaw, an Extension economist.
With the assistance of a computer software program, Extension economists input every aspect of a producer's operation including machinery, income, inventory and other factors that will calculate a risk component prior to making a costly financial decision.
The program takes into consideration market conditions as well as past yields to help give the producer an expected average return on investment.
"We put all of that information into a model and link it with forecasts from different groups," Outlaw said. "That can help project in the future what the financial condition of the farm or ranch will be, also throwing in with it a risk component."
Outlaw said 1996 and 1998 were two years of drought that took their toll on the cattle industry. Many producers who decreased the size of their herds were looking to rebuild in 1999. However, dry conditions have prevented those ranchers from replenishing herds.
"In terms of going through a dry fall of 1999, they didn't have as many cows and what little grass there was, it went a little further than normal," Outlaw said. "But someone trying to get out of that situation, and we've worked with some people coming out of the 1998 drought, their question is, ‘I've got this land base that needs 400 cows for me to be able to make my debt payments. Right now, I've got 250 cows, what's the most economical way to make my limited resources go further?'"
The program would help the producer analyze a number of alternatives, he said. Those include keeping replacement heifers and building back the herd over time. Another alternative would be to buy pairs of cattle.
"You might buy a certain amount this year, a certain amount next year," Outlaw said. "We could put that in as a second alternative and in doing that, put in borrowing. What we're doing here is financial planning. How much can they borrow? How much debt can they service? With cow-calf operations, there isn't much room for error. That's enhanced even more because when you're coming off droughts, that affects calving percentages for next year."
With cow-calf operations, calculating risks is a bit more extensive, Outlaw said.
"It's easy to describe crop operations, we have risks for yields and prices," he said. "On a cow-calf operation, risk on price is obvious, but there are also risks associated with calving percentages as well as weights."
Most farmers can multiply the commodity price times the expected yield per acre, but, Outlaw said, that equation never gives the producer average prices or average yields.
"You have to go back and build a distribution on the risk," Outlaw said. To do this, Outlaw said producers have to ask the question, what were the yields over the last 10 years on a piece of land?
"That 10 years gives us a distribution to use," Outlaw said. "We do each year up 100 times drawing different pricing and yields. When you take those 100 observations of income, wealth and other financial measurements, we come up with an average.
"And on average, people do pretty good, but it's that one year out of 10 that's a bad year that knocks people in their teeth. What we do is try to build as much realism into our projections without putting too much of a numbers burden on producers."
Droughts get farmers to thinking about installing irrigation systems, Outlaw said. For example, a farmer looking to install a $60,000 irrigation system could have his plan evaluated.
"The analysis would help them decide if they could afford it," he said.
Outlaw said it will help them answer questions such as, "Is the reduction of risk in my yield or increase in yield going to offset the money that I'm going to be paying on this note?" he said.
For ranchers, the FARM Assistance program can also be a valuable tool for exit planning when facing a drought situation.
"We've worked with some people before who have gotten out of the business," Outlaw said. "There's some incredible tax implications for producers. If they bought their land 50 years ago, and paid, say, $50 an acre, they may be able to sell it now for $1,000. The problem is they are going to be paying taxes on the difference of what they paid for it and what they sold it for. You've got to really plan in that regard."
Producers pay a $250 subscription fee for the service. Producers sit down with an Extension economist and provide all financial information pertaining to the operation. After a computer analysis is performed, producers receive a bound report.
"It's a pretty powerful what-if [tool]," Outlaw said. "A person just needs to keep it in that perspective. It's really about the comparison between what they are doing now and what they are looking at [in the future.] It isn't going to tell them reality, but they will have a good understanding."