By Galynn Beer, Senior Sales Manager
Making planting decisions is a challenge. Weather uncertainty always exists and that alone can result in a conservative approach to inputs. Price fluctuations weigh in, as well. How many farmers actually calculate break-evens to help with marketing grain? I’m guessing a relatively low percentage.
Doing The Math
The quickest math to calculate, and probably the math that drives a lot of decisions is gross revenue. I’ve done it and so have most farmers. We intend to be more thorough, but that quick calculation will move us toward seeking information to support that quick decision. A little more analysis is beneficial and helps separate the intuitive, or emotional decision from a more thorough process.
Making Good Decisions
How do we make sound cropping decisions? Some of this has to be analyzed at the micro or individual level. Rental agreements, land costs, equipment costs and other expenses impact break-even prices. With annual crops, we have a great degree of latitude to change, but how does one decide between wheat, corn, soybeans, cotton, hemp, or other annuals? First, what crops can realistically be grown? It can be tempting to grow crops on the fringes of the growing geography and assume all will turn out.
One success story usually is over-generalized to become assumed success in all years. Big mistake. The world of statistics is littered with events that happen on each end of the ‘unlikely’ spectrum. It’s dangerous to make a change based on this. Probabilities for success need to be considered.
Next, where is the closest market . . . where can I turn my inventory into cash? Is it distant? Will freight charges erode the projected profits? And the buyer of my grain – where is his market? If it is far away, even an export market, he will likely protect that distance and risk by lowering what he’ll pay. Is the market for what you are growing big? Can it easily be over-done and create excess supply? Crops like quinoa can look attractive, but a swing of 100,000 acres is huge in a specialized crop. Consider these possibilities. Is the crop insurable in your area? If not, how will you protect your risk? Also, you have to consider the impact to capital. Don’t assume that your banker will agree with what you consider a good decision. Some crops are just more capital intensive, and a great deal of risk is accepted up front. It isn’t cheap to grow corn. Cotton takes a lot of trips across the field. If you don’t have capital to finish what you start, then the outcome will fall short of expectations.
Establish An Expected Value
It’s easy to evaluate an opportunity based on the best or worst outcome. We typically remember outlier events and not averages. 300 bu/acre corn, 5 bale cotton, 100 bu/acre soybeans, these results stand out. But averages are where decisions should be made. By looking at averages, we can establish an expected value. If 3 bale cotton at 60 cents a pound is a 10 year average and 220 bushel corn at $3.80 is also a 10 year average, now you can begin to make a decision. If we look at these normal yields, we can then calculate realistic break-evens and profit margins. If 3 bale cotton, with typical quality, will result in $150/acre and 200 bushel/acre corn will produce $100/acre profit, the decision seems clear. But here is where historical averages matter most. Optimum quality for cotton doesn’t always occur. There are likely years where yield is achieved, but quality isn’t and we don’t reach the profit per acre we expected. If quality and yields align to produce $150/acre profit 50% of the time, but 200 bushel corn produces the $100/acre 80% of the time, the winner, believe it or not, is corn.
How, for cryin’ out loud? 150 versus 100 is easy math; $150>$100 so the seemingly obvious winner is cotton. But this is about what profit we can typically expect, so $150/acre that happens 50% of the time produces an expected value of $75/acre while $100/acre occurring at a rate of 80% of the time produces an expected value of $80/acre. When you evaluate it this way, $80>$75 and corn wins. This is why consistency often wins out over the long haul. The more variables that need to come together to produce the profit you are evaluating, the lower the success rate. Protein in wheat, a certain size of potato, a certain timing for watermelons and strawberries to hit the market; these are all factors that can influence the realistic profit we can expect. But in fairness, if cotton produces $250/acre profit only 40% of the time, that’s still an expected value of $100/acre and would beat the $80/acre of corn. Cotton may not win as often, but when it does, it wins big. Just be realistic about yields, profits and percentages of wins.
If you’ve never planted potatoes, or sugarbeets, or sesame, it’s unlikely the equipment you need is parked out back. You’ll have to buy it. Are you buying during a heavy conversion toward a crop? You’ll pay a higher price for the needed equipment because demand is elevated. If the market for the crop goes south, you’ll likely want to turn those assets into cash when everyone else does, resulting in reduced prices because of the supply of equipment. And some equipment is very specific, such as a cotton stripper. You can’t decide to harvest wheat with it. So how long do you need for the cost of switching to this crop and equipment to pay off? Markets don’t stay high forever and can influence how soon we thought we’d pay that piece of equipment off. So make sure to re-read the previous paragraph to decide if switching costs are worth it.
The last part of a decision we’ll discuss here is critical, and often overlooked . . . the impact to cash. If cotton hits $1/lb and you evaluate all of the above and decide it’s a good decision to plant cotton, sometimes we forget to think about the impact to our cash flow. If you are growing corn, you can choose to convert the grain inventory into cash as soon as you harvest it. Cotton is much more complex. Payment generally doesn’t start until after the cotton is ginned. That can be months after it is harvested. Then, generally there are marketing pools that pay the remainder out over several more months. So a simple switch can negatively impact cash flow. Capital that might be available in November of the current year with corn, may not totally be realized until November of the following year if you switch from corn to cotton. Depressed wheat prices can dissuade planting, and turn those acres into corn, cotton, or something else. However, wheat provides cash flow at a time when most other crops don’t. There may be a time when a lower profit might be a preferred choice because it creates cash flow at an important time. Also, there is the cash cycle to consider. If you plant cotton in May of one year and get your money in November of the following year, then your cash cycle, the time period from when money leaves your bank account until it returns, is 18 months. Corn planted in April and liquidated in November of the same year means your cash cycle is only seven months. A long cash cycle can result in periods of a cash crunch.
The other aspect of this is hidden for sure. Inflation, even if it is low, results in reducing the purchasing power of money. If you liquidate your inventory of corn in November of one year at a profit of $100/acre and get a profit of $100/acre back from cotton the following November, it is $100 in both scenarios and seems the same. But the $100 profit from cotton won’t have the buying power of the $100 profit from corn; time and inflation will have eroded the buying power of the $100 from cotton. The profit from cotton is much more likely to have a buying equivalent of $97 or $98 since the 12 months of inflation will have reduced its purchase power. This often goes unnoticed.
The Final Word
Don’t take crop decisions lightly. A lot of variables should be considered. Gross revenue and net profit are generally relied on, but there are other considerations that are important. We remember outlier events, but you should base decisions on averages, along with other impacts to the business. Seek advice from others. This can help to alleviate biases. But seeking someone who is convinced of the same decision as you won’t provide a different perspective. Try to find someone who will challenge your decision. Emotional decisions can be the enemy of long-term success. You owe it to yourself to be thorough.