Agricultural Trends

January 24, 2024

Agricultural Economics and Finance: Views from the Rearview Mirror and Windshield

By: Dr. David M. Kohl

People often say that time seems to accelerate as one ages. Of course, I can defend that comment because I am that age and demographic. The year 2023 has quickly gone by and movement towards the quarter-century mark is upon us. A rearview mirror examination of the first full year post-pandemic has revealed some interesting twists and turns impacting business and financial outcomes in agriculture.

The rapid acceleration of interest rates has impacted producers' cost of money, particularly for operating lines of credit that are often structured on variable interest rates. For many commodities and enterprises, prices received have declined or stagnated while inflated costs have been slow to correct. This has reduced net profit margins and, in some cases, has created negative margins. Those who have debt locked in on fixed interest rates or carry little or no debt have been able to circumvent the wrath on profits of increased interest rates. Others maintained a lid on costs by seeking purchase discounts and other opportunities that have resulted in favorable cost reduction outcomes. A disciplined approach to marketing and risk management decisions by using tools such as crop and livestock insurance has paid dividends for many producers. In retrospect, these have been some of the lessons learned in this part of the economic cycle.

Geopolitics, military actions, weather aberrations and de-globalization have created extreme economic volatility in the agriculture industry. The economic slowdown of major players in the global economy, who are important to U.S. agriculture export markets, has challenged some of the supply and demand balances.

In summary, the margins of error have become thinner for financial and business decisions being made by business owners and managers in agriculture. Price and cost volatility require a more disciplined approach to short- and long-term buying decisions where emotions can run high. These situations require one to channel energy into making objective business decisions. An examination of farm record databases from numerous groups finds there is a widening range of profitability and financial outcomes among agricultural businesses. Top-level managers, measured by profitability, are garnishing the benefits of proactive management. At the other end of the spectrum, lower-level profit farmers and ranchers have seen their margins narrow or become negative.

Top-level managers and owners, measured by profits, have much larger nest eggs of working capital to weather economic setbacks compared to those in the lower profiles of profits. The bottom line is that managers with high levels of business and financial IQ are more likely to plan, strategize, execute and monitor a successful business plan and have positive results in the post-pandemic economic environment.

Windshield view

Now, let's turn our attention toward 2024 and beyond. First, interest rate increases have a high probability of leveling out. On the other hand, interest rate declines will be enacted slowly by the central banks in the U.S. and abroad. Here in the U.S., Fed leaders are fighting the ghost of Paul Volcker, former Federal Reserve Chairman of previous decades. Under his leadership, he raised interest rates to record levels while reducing inflation. However, when he reduced interest rates the inflation returned.

The Federal Reserve will closely monitor the headline inflation with a desired level of 2%. Moving toward this level could foreshadow a reduction in interest rates. Next, if the U.S. economy has negative quarterly growth and the unemployment rate increases to 4.5%, as measured by the U-3 unemployment rate reported on the nightly news, this could signal a possible decline in interest rates. In the longer term, as many develop plans for business expansion and growth, interest rates will most likely be back to “normal levels” compared to the zero-bound levels from 2008 to the pandemic era. It appears that lower interest rates with small amounts of volatility are in the rearview mirror of the past.

There is an old adage that says prices received will readjust quickly, but costs will come down very stubbornly unless there is a major economic shock. These elevated costs have a two- to three-year lag compared to when prices received decline.

When viewing the future economic landscape, extremes in political and military action globally are a given. Therefore, extreme economic volatility will likely persist. Changes in consumer patterns in the U.S. and abroad will require alignment of products and services with the evolving markets that will change at an accelerated rate in the future. One must have profit strategies that will proactively utilize new technology and innovation, which will impact engineering, biological and information systems in a producer’s playbook. However, one has to quickly assess the land, labor and capital resources and the marketplace to ascertain if there is a fit for your business. Whether you are implementing a high-tech or low-tech strategy, being resourceful and innovative will be keywords in the proactive management mindset.

Quarter-century management mindset

Regardless of size, enterprise or geographic location, the management mindset will be a high priority moving toward the quarter-century mark. The “five percenter” mentality, that is being 5% better than your peers in production, operational efficiency, market and risk management, finance and human resource management, is a goal to aspire to.

Basic goal setting, within your core values and vision, is a high priority that is often overlooked. Only 4% percent of Americans write down their goals and follow through in this goal-setting exercise. Goals provide the impetus for focus in a world of distraction and chaos. The five percenters will write down short-term and long-term goals for their business, family and personal life.

A quarter-century management mindset requires a strategy of working capital management. This is particularly important in an environment of thin margins and extreme volatility. The proper management of the top half of the balance sheet, meaning current assets and current liabilities, provides a financial shock absorber when adversity arises and positions one to capitalize on opportunities when liquid capital can be deployed. Strong current ratios above 1.5 to 1.0 and working capital to expenses greater than 25% can be a good starting point. However, one must examine the quality of current assets such as inventory, accounts receivable, prepaid expenses and cash and match them with cash flow demands and the timing of current liabilities.

Transition management in agriculture will accelerate as the baby boomer generation ages out. This group, which owns many of the farms and ranches, is moving to another stage of life where healthcare and personal motivations require the transfer of assets and management. In many agricultural businesses, building bench strength with individuals who have a global business outlook rather than being “siloed” will become very important. A good facilitator or coach with a transition management team can be looked at as a good investment rather than just a cost in monitoring the progress to completion.

More successful businesses are developing key performance indicators (KPIs) to monitor business performance. These metrics could be used in production, operational efficiency, finance and other areas. Often the KPIs can be compared to peer benchmark data. Again, the KPIs keep one focused, on task, and are a great method to motivate team members to productive and effective performance.

Finally, a strong management mindset requires a deliberate educational program for people in the business. Managers should also read industry publications, listen to podcasts and attend selected field days. An educational program is a strategy for a competitive edge and should be a high priority for information and knowledge that is diffused into business decisions and strategies. As a presenter at many of these educational events, the information, networking and sharing of challenges and opportunities recharges the “batteries” not only of the business, but life in general.