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Managing financial risk in agriculture during turbulent times.

If you like roller coasters, this is a great time in U.S. agriculture. But if you're like the rest of us, the ups and downs of this marketplace can leave you feeling dazed and confused, if not downright sick to your stomach.

Managing business risk is more difficult now than ever, and it must be done diligently. A company typically has a total risk level that it is willing and able to accept. This level is a combination of business and financial risk.

Increased business risk means that you must more carefully manage financial risk, which is the likelihood that your company will have enough cash available to meet obligations to debtors. Increasing working capital and credit reserves, along with thinking creatively about growing your business, will help you better manage your financial risk.

WORKING CAPITAL AND CREDIT RESERVES

Most of us consider working capital as not actually "working" since it does not earn a return. In stable environments, this is generally true. But, in more volatile environments, working capital acts as the insurance premium needed to help reduce financial risk.

Increasing working capital, particularly short-term assets that can easily be turned into cash, is one way to reduce total risk. It allows you to hold more of your retained earnings as cash, CDs, or money markets.

Other ways to increase working capital include increasing your credit reserves and restructuring debts so that a smaller portion is due in the current year.

In today's volatile market, your lender may be hesitant to help you with these alternatives, but if the total risk for your business needs to be reduced, due diligence suggests that you should at least ask.

BUSINESS GROWTH

Assuming you have a good working capital position and have been profitable, you likely have retained earnings to invest. To maintain an acceptable total risk level in uncertain times, you must pursue growth with caution.

This may mean investing in the current operation to increase revenue and/or reduce costs rather than investing in additional long-term assets, such as new locations, whose value may prove to be highly uncertain.

You may also need to grow more slowly than you would like--you will want to manage the financial risk by using a higher portion of retained earnings and less debt. Finally, you may need to think creatively about growing the business through partnerships or other arrangements that allow for the strategic flexibility needed to make adjustments should market conditions take a turn for the worse.

Although there is no simple answer for overcoming the daze and confusion you may feel in today's agricultural marketplace, understanding that a company's total risk level consists of both business and financial risk can help you identify options.

Think about using the information and tools available in the marketplace to handle business risk and focus on managing margin risk, not just revenue risk. To manage financial risk, think critically about working capital, credit reserves, and growth strategies.

BUSINESS RISK MANAGEMENT TIPS

In addition to financial risk, you will need to manage business risk to maintain an acceptable total risk level. Here are a few tips.

* Know your markets, costs, and commitments.

* Use credible sources to anticipate market changes/shifts.

* Consider marketplace risk management tools (futures, options, insurance, etc.).

* Focus on margin risk, not just revenue risk.

* Limit unprotected inventory positions.

Dr. Allan Gray is the Director of the Center for Food and Agricultural Business at Purdue University. He can be reached at: gray@purdue.edu.
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Title Annotation:Insights from Purdue University
Author:Gray, Allan
Publication:Agri Marketing
Date:Apr 1, 2010
Words:580
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