Effective risk management key to future arable profits

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A simplified ‘business risk register’ could help arable growers manage the higher level of risk they are facing next season because of inflationary pressures and market volatility.

High commodity prices means that good margins should be achievable for 2022 and, to a lesser extent 2023, but the hikes growers have seen in fertiliser, fuel, machinery and labour costs have driven up production costs making it a high-risk period.

“Growers will end up spending more on the crops they will soon be drilling than ever before, but if they take steps to mitigate those risks, it is looking that some good margins will be achievable,” says Jonathan Armitage, head of farming at Strutt & Parker.

“Our modelling points to the potential for arable margins in 2023 to be up to three times what they were in 2021, but this will be in tandem with a doubling in the working capital requirements.”

While farmers make decisions about managing risk every day, as the stakes get higher it is worth taking a bit of time to stand back and perhaps approach it in a slightly more organised way, explains Mr Armitage.

“A business risk register is a tool commonly used in the wider business community but not so often on farms. It can be a simple list or spreadsheet where you capture the severity of the risks facing your business, calculate the potential impact of a risk event happening and then think through how to go about mitigating those risks.

“It may sound daunting but capturing all this information in one place gives you clarity about which risks you need to prioritise and helps to keep you on track.

“Some of the considerations will be second-nature to well-organised, progressive farmers, but thinking them through in a structured way in terms of their relationship to risk makes you think about the consequences of something going wrong in a way that you may not have before.”

Mr Armitage shares some tips for areas growers may want to consider in their analysis and some thoughts on areas to watch in terms of balancing risks/rewards:

Production risks:

Most farmers adopt production risk management strategies in an informal way. For example, choosing the most suitable varieties for your location, drilling on the right day and paying absolute attention to the agronomy of the crop are the best approaches to mitigating the production risks posed by pests, diseases and the weather. Having a broad rotation of crops and varieties can also help to spread risk, as will producing for specific markets.

This will be a year when the costs of drilling crops in sub-optimal conditions will be felt most keenly, so it will be important not to be tempted to try to maul crops into ground in less-than-ideal conditions. Plans will need to be flexible and growers will need to be willing to adapt as the situation changes.

If using a contractor, choose them wisely. You want to be dealing with someone who is well-financed and well-staffed. Some contracting businesses are getting very large and so consider where you might be in their list of priorities. Paying a bit more to get the level of service you want may be better for your business in the long term.

Knowing when to write off a crop and not spend any more money on it will become increasingly important. The area of oilseed rape grown next season is forecast to increase significantly in response to strong prices – so this is likely to be a conundrum facing many growers. When making the decision as to whether you are prepared to plant OSR, risk-adjusted gross margins can be useful. These involve working out before you plant a crop, what the financial implications will be if you end up writing a proportion off.

Financial risks:

The financial risks that different farming businesses may be willing to take will differ – reflecting factors such as your current level of borrowing, whether you are tenant who will have to pay the rent come what may, and your requirements for living expenses.

Being on top of your financial risks involves identifying and quantifying the risks you face and working out the potential impact on cashflow and profits.

Look at what happens to your cashflow and profits if, as is expected, interest rates rise. Consider a sensitivity analysis to examine the impact of say a 2% rise in interest rates on both cashflow and profits.

It will be more important than ever for farmers to have cashflow forecasts for the next 18 months and be on the ball about revisiting them on a regular basis. The level of working capital investment that will be required over the coming months is sufficiently high that it could cause cashflow complications that will be a real threat to the future of some businesses.

Remember, growers will get a 50% advance on their Basic Payment Scheme (BPS) claim in July with the balance paid in December. However, Harvest 2022 is looking like it will be a profitable one for growers who bought their inputs before the big price rises took effect which means there could be some big tax bills to pay next year.

Input price risks:

If buying fertiliser at £600-700/t for next season on the basis of a forward wheat price of £270/t, then you can reduce your exposure to risk by forward selling a proportion of the Harvest 2023 crop to lock in that margin. Fixing a price in such circumstances can be a sensible risk management decision – even if it does turn out you could have got a higher price by holding back.

Consider your level of exposure to commodity price changes on a crop-by-crop basis – for most people the biggest exposure is to changes in the wheat price – and make sure your day-to-day decisions and sales strategy are in line with what that analysis shows. It may sound obvious, but make sure you prioritise the enterprises that are likely to make the most money.

Debt risks: 

Manage the risk of bad debts closely by knowing your buyers and keeping an eye out for any changes in business practices – such as late payments – which might signal they are suffering cashflow problems. Limit exposure by managing collections and payments and obtain appropriate credit insurance if necessary.

Policy/legislation risks:

Have a think about any bits of legislation that we know are around the corner which will have an impact on your business. For example, a business which is highly reliant on irrigation could start planning for changes to water abstraction charges and licences.

Some changes will be imminent – cuts to BPS payments (in England) – while others may be some way off, such as considering what would happen if one of your major customers started to require suppliers to be carbon neutral.

Personnel risks:

Having the right people in place is critical for the success of a business and finding good staff for arable farms is getting harder and harder. Consider now what would happen if one of your staff members was unavailable for work because they had resigned, was ill or retired. Who might be able to fill the gap in the short term? What about the long term?

Ensure you have a contingency plan in place and share knowledge around the family and any staff, so the business is not completely reliant on one person.

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