Wednesday, April 16, 2014

Managing Drought Risk on the Ranch

Financial Management Before Drought

"In the short run, your business is what it is; in the long run, it is what you want it to be."

Economists make two generalizations about business that may be helpful in building a sound business and drought plan, since the drought plan is only a small part of the overall business plan. At a particular point in time, say three months, very little can be done to alter the type of operation you have, whereas over a longer period of time, several years, there isn’t anything that can’t be changed. So in the short run your business is what it is, in the long run it is what you want it to be.

The Business Plan

"I argue, as you’re going through a drought, that’s the number one thing that you’ve got to have. You’ve got to have a good analysis of your business. Walk yourself through it and project some alternatives ahead of time, rather than try to experience them and say "oh my gosh I did the wrong thing." We can’t undo that. But if we can anticipate, through some projections, strategy one works better than strategy two, then we try to focus on the management decisions needs to implement that strategy one.” (Harlan Hughes)

One of the biggest steps in having a viable drought plan is to have a viable business plan. One of the first steps in developing this business plan is to make an analysis of your current operation. This would include an assessment of the business structure, physical attributes, biological capacities, and the human and financial resources.

Performing a SWOT analysis (analysis of strengths, weakness, opportunities, and threats) is one method of accomplishing this task and can be a helpful and insightful exercise. Based on the SWOT analysis you will be able to identify the potential enterprises which may be viable considering all your competencies and resource endowments. 

As part of the SWOT exercise a detailed financial analysis of each enterprise and the effects of drought should be considered. The financial analysis procedure such as a partial budgeting, including variability, is helpful in this regard. (Partial Budgeting for Drought Management)

Based on this analysis, you may decide to make changes in the way you operate your business to mitigate risk including drought, and capture benefit from your identified strengths, limit impact of weaknesses and threats, and to eventually reach your goals and objectives.

Financial Resources

"To be truthful, if ranchers really want to plan for drought, they need to have a lot more resources than they need. It’s kind of like, up in northwestern Minnesota, their tractors are huge for the size of land they have, because they’ve only got so many weeks in the growing season so they’ve got to get out there and get it done. So they have a lot larger tractor than say, someone down south who has the same amount of land and half the tractor. And I think that’s the same with drought. If you’re in a highly drought prone area, what you want to do is you want excess capacity. In other words, you want a lot more land or availability of forage. And you want to be able to take that forage and have it, kind of bank it. And that’s probably the strategy that would be most successful, as I look at it. And that’s why guys keep hay that’s around 3 or 4 years, that sort of thing. Same kind of idea.” Matt Stockton

Without diminishing the importance of assessing other resource endowments, in managing drought events, a careful assessment of your financial resource is critical. Accurate and timely information on financial health of your ranch operation to a great extent will determine the degree of flexibility you have in coping with drought events. Financial measures of liquidity and solvency of a business such as net cash flow, debt to asset ratio, net worth, and change in net worth are helpful tools in determining financial health of your business.

Good financial health increases your ability to recover from and bear more risk which provides a room to consider decisions which may result in higher profitability for your operation. For example if you believe that a drought is developing you may choose to cull heavier in the spring to conserve grass and expense. This decision may result in reduced income if the drought does not materialize. Since your business is financially healthy the loss of income would not hurt near as much as had the drought occurred and loss of pasture and income due to a forced sale. There are many other examples where having a good financial health provides flexibility in coping with events such as drought.

Stocking Approach and Net Returns

 

Since drought is a common event in arid regions, the approach that livestock producers utilize to estimate and stock their landscapes has much to do with the reliability of their net returns on operations.

A 100-year study of drought impacts on livestock operations in Australia had three basic conclusions that provide some insight into stocking mentality and economic returns:
• Producers who optimistically stock their rangelands for “good” years and feed in the deficit years have the lowest net returns and the highest variance in net returns.
• Producers who de-stock in deficit years as soon as possible, have more net returns and less variance in the returns.
• Producers who stock conservatively have the lowest variance in net returns, but fail to capture “bumper crop” returns from excellent forage production years.

Exerpt:  Drought Impacts on Colorado Livestock Operations – Scott Cotton


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