Two Tips to Strategically Take on More Debt
Farm loans have been a huge help to agricultural businesses of all kinds for generations. Most farmers look to obtain a loan to generate a return on their investment. On a recent PDPW Dairy Signal webinar, Dr. Kevin Bernhardt, professor of Agribusiness at the University of Wisconsin-Platteville, and Dr. Charles Nicholson, an associate professor at the University of Wisconsin-Madison, talked about the importance of understanding your cost of production.
According to Bernhardt, at 4% interest, producers are generally getting a good return on their investment. However, as interest rates have increased, that changes the outcome. This is why Bernhardt recommends producers not only sharpen their pencils, but also run a sensitivity test of what will happen when prices increase, interest increases, and other variables change.
“As you do your budgeting, do your due diligence,” he says. “Make sure you look at the variety of prices and interest rates and determine what your risk is.”
While there is no magic formula, Bernhardt reiterates that numbers matter when it comes to reducing the cost of production for producers to achieve profitability in 2024.
Push the Pencil
“There's so much that rides on the razor's edge for profitability,” Bernhardt says. “Prices, interest rates and export markets are all volatile. We must be able to push that pencil and see where our risks are.”
Conducting a sensitivity test provides producers with the confidence to make the next decision.
“A little bit of change in price makes a huge difference in whether this is a profitable or loss,” he adds.
Benchmarking is Helpful
Nicholson highlights the importance for producers to benchmark against their own farm—year-over-year, as well as against other farms that have some similar characteristics.
“It's about monitoring your continual improvement and looking at what works and what doesn't for you,” he says.
Producers must pay attention to understanding how future debt will provide a return on their investment. Nicholson shares that during low-profit years many farms had to do some restructuring of financing because the loan payments were too much.
“We pushed some of those payments down on the balance sheet for later years. And, at times that was a must. However, you also want to remember what you're doing to yourself,” he says, questioning if producers are still paying a machinery loan on machinery that's long gone, then they must ask, ‘How much return on our investment are we really getting?’”
With interest rates much higher than a couple of years ago and inflation impacting almost every good and service, producers not only need to crunch numbers frequently to understand their cost of production, but they must continue the conversation on how to strategically take on future debt.
