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Wednesday, March 17, 2010

Understanding Financial Risk....

is yet another portion of the Risk Management "pie".

Financial Risk has 3 basic parts:

- the cost and availability of debt capital
- the ability to meet cash flow needs in a timely manner
- the ability to maintain and grow equity

Cash flow is very important because of so many ongoing farm obligations, i.e. cash input costs, cash lease payments, tax payments, debt repayment, and family living expenses. Often, off-farm employment can be a financial risk strategy. It ensures that living costs are met, raises the standard of living and may reduce the need to liquidate farm assets.

Financial risk should be managed through sound planning and financial control. Monitor your ability to bear financial risk continuously.

A set of well-maintained financial records is critical to maintaining financial control of a farm or ranch. This helps in evaluating past performance and planning for the future. Some essential financial documents include the balance sheet and statement of equity, income statement, and project and actual cash flows. As the operation grows, more records will be needed – ratios such as debt-to-asset, debt-to-equity, and asset turnover are important monitoring tools.

There isn’t much anyone can do about interest rate risk; however, by lowering your debt-to-asset ratio and having crop insurance as well as a sound marketing plan, you can sometimes influence your interest rate. Add maintaining accurate financial records and a consistent record of timely repayment of loans and you can expect continued access to debt capital when you need it.

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