Effective risk management key to future arable profits

A simplified ‘business risk register’ could help arable growers manage the higher level of risk they are facing next season because of inflationary pressures and market volatility.

High commodity prices means that good margins should be achievable for 2022 and, to a lesser extent 2023, but the hikes growers have seen in fertiliser, fuel, machinery and labour costs have driven up production costs making it a high-risk period.

“Growers will end up spending more on the crops they will soon be drilling than ever before, but if they take steps to mitigate those risks, it is looking that some good margins will be achievable,” says Jonathan Armitage, head of farming at Strutt & Parker.

“Our modelling points to the potential for arable margins in 2023 to be up to three times what they were in 2021 – but this will be in tandem with a doubling in working capital requirements.”

While farmers make risk management decisions every day, it is worth doing so in a more organised way as the stakes get higher, explains Mr Armitage. A business risk register is a tool commonly used in the wider business community but not so often on farms.

“It can be a simple list or spreadsheet where you capture the severity of the risks facing your business, calculate the potential impact of a risk event happening and then think through how to go about mitigating those risks.”

It may sound daunting but capturing all this information in one place can provide clarity about which risks need to prioritise to keep a business on track, says Mr Armitage. Outlined below, there are other actions growers can take too in terms of balancing risk and reward.

Production risks

Most farmers adopt production risk management strategies in an informal way. This includes choosing the most suitable varieties, drilling on the right day and paying attention to the agronomy of the crop.

This all helps mitigate production risks posed by pests, diseases and the weather.

Having a broad rotation of crops and varieties can also spread risk. So too will producing for specific markets. Plans should be flexible and growers must be willing to adapt as the situation changes.

This will be a year when the costs of drilling crops in sub-optimal conditions will be felt most keenly, so it will be important not to be tempted to try to maul crops into ground in less-than-ideal conditions.

If using a contractor, choose them wisely. You want to be dealing with someone who is well-financed and well-staffed. Some contracting businesses are getting very large and so consider where you might be in their list of priorities. Paying a bit more to get the level of service you want may be better for your business in the long term.

Knowing when to write off a crop and not spend any more money on it will become increasingly important. The area of oilseed rape grown next season is forecast to increase significantly in response to strong prices – so this is likely to be a conundrum facing many growers.

When making the decision as to whether you are prepared to plant oilseed rape, risk-adjusted gross margins can be useful. These involve working out before you plant a crop, what the financial implications will be if you end up writing a proportion off.

Financial risks

The financial risks that different farming businesses may be willing to take will differ – reflecting factors such as your current level of borrowing, whether you are tenant who will have to pay the rent come what may, and your requirements for living expenses.

Being on top of your financial risks involves identifying and quantifying the risks you face and working out the potential impact on cashflow and profits.

Look at what happens to your cashflow and profits if, as is expected, interest rates rise. Consider a sensitivity analysis to examine the impact of say a 2% rise in interest rates on both cashflow and profits.

It is more important than ever for farmers to have a cashflow forecast for the next 18 months – and revisit it regularly. The need for additional working capital over the coming months is so high it could cause cashflow complications that will threaten the future of some businesses.

Remember, growers will get a 50% advance on their Basic Payment Scheme (BPS) claim in July with the balance paid in December. However, Harvest 2022 is looking like it will be a profitable one for growers who bought their inputs before the big price rises took effect which means there could be some big tax bills to pay next year.

Input price risks

If buying fertiliser at £600-700/t for next season on the basis of a forward wheat price of £270/t, you can reduce your exposure to risk by forward selling a proportion of the harvest 2023 crop to lock in that margin.

It may sound obvious, but make sure you prioritise the enterprises that are likely to make the most money. Fixing a price in such circumstances can be a sensible risk management decision – even if it does turn out you could have got a higher price by holding back.

Consider your level of exposure to commodity price changes on a crop-by-crop basis – for most people the biggest exposure is to changes in the wheat price – and make sure your day-to-day decisions and sales strategy are in line with what that analysis shows.

Debt risks

Manage the risk of bad debts closely by knowing your buyers and keeping an eye out for any changes in business practices – such as late payments –
which might signal they are suffering cashflow problems. Limit exposure by managing collections and payments and obtain appropriate credit insurance if necessary.

Policy/legislation risks

Have a think about any bits of legislation that we know are around the corner which will have an impact on your business. For example, a business which is highly reliant on irrigation could start planning for changes to water abstraction charges and licences.

Some changes are imminent – such as cuts to basic payments in England – while others may be some way off, such as considering what would happen if one of your major customers started to require suppliers to be carbon neutral.

Personnel risks

Having the right people in place is critical for the success of any business. Finding good staff for arable farms is getting harder and harder. Consider now what would happen if one of your staff members was unavailable for work because they had resigned, was ill or retired.

Who might be able to fill the gap in the short term? What about the long term?

Ensure you have a contingency plan in place and share knowledge around the family and any staff, so the business is not completely reliant on one person.