Corn and soybean prices reached all time highs during the summer of 2012 caused by the devastating drought in the Midwest.
Although yields were reduced due to spotty rainfall, many farmers in Virginia are anticipating record income levels due to the high grain prices.
The management of profits generated during periods of high prices will impact the long-term viability of the business.
There is the old adage “the cure for high prices is high prices.” This means that during periods of high prices producers will increase production to cash in on the high prices. The increased production will result in additional products sold in the world market place which will reduce demand for the products and depress prices for producers.
In times of high prices, it becomes profitable for producers to plant crops on marginal cropland which further increases harvested bushels. Consequently, the potential for larger supplies of corn and soybeans available in the market place will place downward pressure on prices and profit margins, if 2013 is a normal year.
Jonah Bowles, Senior Agricultural Market Analyst at Virginia Farm Bureau, identified (at least) five bull markets since 1970.
The average drop in price following a bull market was 45 percent. If the current trend came to an end at the existing market price, a 45 percent fall would extend down to $4.67 for December corn.
A similar analysis was done with soybeans, which showed similar market reactions, but dissimilar years for some of the trends.
Another factor with the boom/bust analysis is the duration of time for the rise and fall. Most of the bull markets lasted 2-3 years, but all of the subsequent low prices, for corn and soybeans, occurred within one year of the top.
The decisions that producers make during periods of high profits margins can impact the long-term profitability and viability of their businesses.
Grain producers should start to take steps to position their businesses and personal finances to weather the future decline in profit margins.
Keep in touch with lender
It is crucial that producers maintain open lines of communication with their lender during periods of high prices and profit margins. I would encourage producers to contact their lenders during late January 2013 and schedule a meeting to review 2012 financial data (updated balance sheet, summary 2012 income and expenses), credit needs and potential equipment purchases.
During this meeting a producer should discuss plans to market the balance of 2012 crops and risk management strategies that are being used to lock in profits for 2013 and 2014 crops with the knowledge of a potential decline in grain prices.
In addition, producers should talk with their lenders about investing part of the profits off the farm to fund retirement, for example an IRA. An IRA is a savings plan that provides the taxpayer (farmer) tax advantages for setting aside money for retirement.
The benefit of a traditional IRA is that the contributions are tax-deductible in the year the taxpayer makes the contribution.
Producers should contact their tax advisors about making up to a $6,000 contribution to separate IRA accounts for the producer and their spouse as a means to reduce their tax liabilities in years of high profits.
When profit margins start to decline; producers should develop priorities of enterprises and investments that will generate the highest returns and ones that should be eliminated from the business.
Yet, while prices/profits are high producers should seek to replenish and build up cash reserves, pay down line-of-credit and other outstanding operating and real estate loans.
Next, the producer should consider investing in income producing assets that will generate the highest returns.
During times of high profits, many producers want to buy “new paint” in the form of pick-up trucks and farm equipment. The decisions to replace and upgrade machinery should be based on whether this investment will increase profits or reduce costs (more efficient planting and/or harvesting) for the farm business.
The new machinery must pay for itself by lowering costs or increasing profits.
Many farmers use the internet to locate and purchase used farm equipment from other regions of the state and country.
When equipment is purchased from dealers and at auctions, the sellers (dealer and auctioneer) guarantees clear title, that is, there are no liens on the equipment.
However, caution needs to be exercised when equipment is purchased at private sales. The buyer needs to check at the courthouse in the county where the seller resides to see if liens (financing statements) have been filed that shows that a third party (e.g. banks, leasing and equipment companies) has a secured financial interest in the property.
If a producer purchases equipment from a dishonest seller who does not satisfy (pay off) a lien at the time of sale, the purchaser is financially liable for the lien. Thus, a farmer may pay for the equipment twice because he paid the seller for the equipment and then has to pay off the secured interest of the lien holder.
The strategic investment of profits generated from recent record grain prices will lay the foundation for the long-term viability of grain producers.
By working together with their lenders, producers can develop a plan to prioritize and diversify the investment of profits into off farm investments and the farm’s infrastructure.
These decisions will help provide an additional source of retirement income and will maximize returns to land, labor and capital in the cyclical grain industry.