FARM Assist Helps Producers
Evaluate The Risk Of Change

By Colleen Schreiber

SAN ANGELO — "Value-based marketing" was one of the agricultural buzzwords of the 1990s. Today "risk management" appears to have taken its place at the top of the terminology heap.

Lenders and economists, however, avow that it's much more than just a buzzword. Risk management, they say, is the key to survival in the new millennium.

Changes in ag policy, specifically "Freedom to Farm," a global marketplace, low commodity prices and ever-unpredictable weather patterns have brought a heightened awareness of the need for risk management programs.

In the past, risk management has often been thought of in the form of insurance programs, futures and options, hedging and the like, but a new program designed to help producers better plan for the future is now in place.

FARM Assistance (Financial and Risk Management Assistance) is a computer-supported long-range planning tool to help producers make more informed decisions about their operations.

Travis Booher, based at the Texas A&M Research and Extension center here, is the District 7 program specialist for risk management. His primary responsibility is to support the Texas Risk Management Education program, the core of that program being the FARM Assistance program.

FARM Assist, Booher explains, incorporates an operation's production history and price history over a 10-year period to build a baseline. The baseline gives the producer a detailed picture of his or her current operation.

The program, the brainchild of Kansas State and Texas A&M universities, has been in the development stages for several years. Soon after the passage of the 1996 farm bill, USDA, realizing the need for better risk management education, established the Risk Management Education Task Force. That task force expanded and branched out, and the two universities teamed up in an ag summit of sorts, where Extension economists met with farmers, ranchers, lenders and other agribusiness representatives to find out what their needs were in terms of risk management.

Twenty-three focus groups were organized, 17 in Texas and six in Kansas. The group consisted of 101 farmers and ranchers, 22 lenders and 14 representatives of agribusiness firms. Participants were asked about sources of risk they faced, the importance of alternative risk management strategies, the way in which they prefer to receive risk management information, and the most appropriate education format for learning risk management strategies.

Participants rated 21 sources of risk on a five-point scale with five being the source of most importance. They identified as their top five sources of risk: commodity price variability, commodity yield variability, changes in input costs, changes in environmental regulations, and unforeseen litigation.

The top three sources of risk and uncertainty, Booher notes, were related to revenue (price and yield) and input costs.

Participants also rated the relative importance of risk management strategies to their overall operations. The top five were debt management, enterprise diversification, forward contract selling, liability insurance, and hedging the selling price.

The end result of these focus groups was development the Texas Risk Management Education program and ultimately the computer-assisted decision model dubbed FARM Assist. Test pilot programs were established in the Panhandle, South Plains and Rolling Plains of Texas. Those programs based in Amarillo, Lubbock and Vernon are now in their second year. The program has since been expanded statewide.

Establishing a baseline, Booher notes, is the most critical aspect of the FARM Assist program, because it's this information against which all other decisions are evaluated.

Information needed for the baseline includes previous tax returns, production history, balance sheets, income statements, etc. Off-farm income or any other sources of income, such as oil and gas, are plugged into the computer model as well.

Once the baseline is established, producers can then compare how their overall operation will be affected if certain changes are incorporated, Booher explains.

For example, if a producer wanted to change his crop mix from cotton to corn or switch perhaps from a straight livestock enterprise to a wildlife/hunting operation, the program can evaluate these changes and compare them to the baseline to see how the changes would impact the overall bottom line. Changes in an insurance program could also easily be evaluated, Booher says.

"Sometimes we find out after the fact that a particular change proved very costly. This program gives producers a chance to evaluate those changes beforehand," he explains.

To evaluate change, a price forecast is developed using a national price forecast determined at the University of Missouri at Columbia as well as the producer's previous year's prices.

"We develop a local price basis, of sorts," Booher explains. "For example, we take what the 1998 national price forecast for calves was and compare it to what the producer received for his calf crop in 1998. If he was $5 above the national forecast, we add $5 to the price projection figure. If he was $5 below, we subtract."

A producer has the option of reviewing price projections, and if he feels they are too optimistic or too pessimistic they can be changed to suit what the individual believes they should be, Booher says.

The volatility or risk that the producer experienced over the previous 10 years is built into the revenue projections for the following 10 years. For example, if a producer experienced two years out of the 10 of really poor crop yields, then the revenue projections for the following 10 years will build in that same risk.

"We're projecting a revenue with risk around it," Booher explains.

Once all the information is gathered and the analysis completed, the risk management specialist prepares a report with an executive summary. Included in this summary is a series of projections and balance and income sheets for up to 10 years.

"Basically, what it will show is if you don’t change anything in your operation based on assumptions we’ve made and you agreed to, here’s the way your operation looks today and here’s how we think it’s going to look up to 10 years from now," Booher says.

"What they may find out is that what they're doing is exactly what they should be doing. They may find that some of the alternatives they've been considering may not be economically feasible. They might see higher income, added risk or even lower income."

The model, he adds, is especially sensitive to cash flow. The analysis will give the probability of net worth increasing or decreasing on a percentage basis if certain changes are incorporated.

All information gathered from individual producers is proprietary, Booher notes. The specialist gathering the information is the only one able to tie that information back to an individual producer. A confidentiality agreement is also signed.

The program is fee-based. Currently, $250 allows a producer to obtain the baseline analysis plus an evaluation of two alternative enterprises. Each additional alternative thereafter is $50. The fee, Booher says, is expected to increase September 1.

"Ideally, we hope that producers will update the baseline data annually so they can continue to monitor any changes and make more informed decisions about their overall operation," Booher says.

"FARM Assist is nothing more than a decision aid," he reiterates. "It’s not the answer to all things. The value, the greatest benefit of this program, is that it provides a producer with better information than he's ever had before."

And, better and more detailed information is exactly what most ag lenders are requiring today.

Brenda Kellermeier, senior vice president of Crockett National Bank, San Angelo, understands the importance of risk management because she deals with it every day. She's been in the ag lending business for the past 15 years. At Crockett National, about 30 percent of their loans are agricultural loans.

"We're a West Texas community bank, and we understand agriculture, and because of that we are not shying away from ag loans, but we are becoming more conservative and we do expect more from our borrowers than we have in the past," Kellermeier says.

"The last five years have been really tough for farmers and ranchers in our area. The last really good year was in 1991; there's been some average years in between. Right now projections for cotton in this area are in the mid-40 to 45 cent range at harvest. We're talking $2 corn. I don’t know a producer who can grow corn or cotton for those prices."

Because of the new farm policy and the fact that U.S. consumers expect cheap food, Kellermeier says, risk management has become even more critical.

"In ag production, it doesn’t matter what commodity you're in, you need some kind of risk management plan."

Any good risk management program, she notes, begins by determining a bottom line cost of production, not just for the enterprise as a whole but for the various enterprises within an operation — for example, leased land versus land that is owned outright, versus land the producer is making payments on.

Establishing a marketing plan is another key element to a good risk management plan, Kellermeier notes. She encourages her borrowers to spend at least 15 minutes a day working or studying their marketing plans.

"Most producers just produce and sell without giving much thought to marketing. So many of us take our crop to the auction barn or the co-op and we take what we get. We haven’t done any planning to say, 'this is my cost of production this is what I have to get to break even.' And then, 'here’s my goal; this is what I want for my crop.'"

Producers also need to be more goal-oriented.

"Determine what profit margin you want, and when you see that profit margin, take it. Don’t get greedy."

Any prospective borrower, Kellermeier says, must be able to identify what he does better than anyone else.

"In the long run, the commodity business only offers an opportunity for those producers who have lower than average cost of production, superior performance, or better than average returns," she explains.

"The average producer will continue to be squeezed out by market pressures. You've got to be able to do something better than the next person down the road in order to survive."

After that, it's up to the lender to have "a lot of faith in the borrower."

Open communication between lender and borrower, she adds, is critical.

"Let the lender know what’s going on. If there's been a problem, let them know what you're doing to correct the situation."

Currently there are eight risk management specialists in place across the state with plans to fill an additional four positions. Those interested in the program should contact their local county Extension agent or one of the risk management specialists in Amarillo, Lubbock, Vernon, Corpus Christi, Uvalde, San Angelo, College Station or Stephenville.

A risk management curriculum is also available. Some of the topics include: "Retained Ownership Strategies for Cattlemen", "Introduction to Futures Markets", "Knowing and Managing Grain Basis", "Income Statement — A Financial Management Tool", "Developing a Marketing Plan", "Farm Income Taxation", and "Impacts of the 1996 Farm Bill on Price and Income Risk".

The curriculum is designed to provide the tools and procedures that can be used to help make risky decisions, taking into account the decisionmaker's knowledge, beliefs, goals and attitudes about risk-taking. The curriculum guide is being authored by Extension economists with the Texas Agricultural Extension Service and Kansas State University Extension Service.

The Texas Risk Management Education program is being administered through the Extension Service. County agents will work closely with Extension economists and the district risk management specialists to deliver these resource materials through workshops, small groups or on a one-on-one basis, Booher says.