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New decision-making tools and loans, such as Compeer’s Organic Bridge Loan, can make it easier for farmers to transition to organic grain production. Photo by Charlie Johnson.

New tools, bridge loan can help farmers transition to organic grain production

By Paul Dietmann

Organic grain production might be an appealing option to conventional grain growers who have been contending with corn prices around $3.50 and soybeans in the neighborhood of $8.25. However, just as it takes agronomic expertise to successfully grow organic crops, it takes economic expertise to manage the farm’s cash flow and working capital during the transition years.

Cash flow is a measure of all the cash coming into the farm and leaving the farm in a given month or year. Cash may come in from the sale of farm products, sale of surplus machinery, off-farm income, or proceeds from loans. Cash leaves the farm through operating expenses, loan payments, new equipment or building upgrade, and to cover family living costs.

If a farm doesn’t have enough cash coming in during the month to cover all the cash going out, a farmer will probably have to tap the farm’s operating loan or dip into its working capital. Working capital is the amount of current assets that remain after subtracting all the farm’s current liabilities. Current assets include cash and anything that will either convert to cash or be used on the farm within the next year.

Managing cash flow and working capital are challenging for any grain operation, whether it is conventional or organic. Cash doesn’t come in until the crops are harvested and sold. And, long before crops go to market, a lot of cash goes out to pay for seed, land rent, soil amendments, loan payments, family living costs, and many other items.

Cash flow difficulties can be particularly acute during the first two years of organic transition. Farmers may spend a significant amount of money on soil amendments during the first year of transition to give the soil time to respond before organic certification. They may need to buy some new equipment, like a rotary hoe or a cultivator. They might devote extra time to learn how to manage crops in an organic system. Crop yields will likely be low. All these things can have a negative effect on cash flow and can deplete working capital.

Tips to Lesson Economic Impact of Transition
Keeping variable costs as low as possible during the transition years is very important. Variable costs are the costs that wouldn’t exist if the farm wasn’t producing anything. Items like seed, fuel, custom field work, and soil amendments are all examples of variable costs. Variable costs are usually paid in cash during the crop year, while overhead costs, such as depreciation, are not.

If the farm has livestock or if there are livestock operations in the area, hay can be an excellent crop to plant during transition. The first-year cash flow will likely still be negative. There are significant costs to establish hay and yield will be low in the establishment year. However, hay is a great soil-building crop. There is usually a decent local market for it—hay is expensive to haul long distances. After the first year, three or even four cuttings can be sold.

Some growers in areas where hay is not a viable option will grow non-GMO soybeans during one of the transition years. The non-GMO premium for soybeans can be as much as $1 per bushel or more, and the cost of non-GMO seed is significantly less than GMO varieties. Also, planting a row crop like non-GMO soybeans gives growers an opportunity to practice using tools, such as a cultivator, that they may never have tried before. Mistakes made during the transition are less costly than they will be with a high-value organic crop.

It’s generally a good idea not to transition too many acres at once from conventional to organic production. Even if conventional crops have not been profitable in recent years, they still might provide better cash flow to the farm than would transitional crops. Organic transition is an investment that pays off in future cash flow, much like a wage earner puts money into a retirement fund expecting a payoff years down the road. And, just like most wage earners can’t afford to put 100% of every paycheck into their retirement accounts, most conventional farmers probably can’t afford to invest 100% of their land in organic transition in one year.

Tips to Manage Finances During Transition
Develop multiyear financial projections that include various crop rotations, machinery purchases and sales, and other economic factors. This sounds difficult, but there is a great new tool available from the University of Wisconsin-Madison called the OGRAIN Compass that will walk growers through the steps. There is also a companion publication, Turning Grain into Dough, that helps explain the concepts used in the Compass. Download these free resources.

A grower should try to maintain a working capital position throughout the transition process that is at least 15% of the expected annual gross income of the farm. In other words, if the farm is expected to gross $300,000 per year, the working capital position should not drop below $45,000. Working capital doesn’t have to be held only in cash. Crop inventories, prepaid expenses, and market livestock are all considered to be current assets and can help maintain an adequate working capital position.

If working capital is likely to drop below the 15% of gross revenue threshold, consider establishing an operating loan before starting the transition process. All principal and interest accrued with a traditional farm operating loan should be paid down to zero each year from operating income. However, this doesn’t fit the cash flow of a transitional grain operation in which cash flow is likely to be negative during the transition years. To help transitioning farmers, Compeer Financial recently created an Organic Bridge Loan Program that allows a grower to obtain an operating loan that requires interest-only payments during the transition years, leaving more cash available to the farm. Once the land is certified organic and cash flow improves, the principal balance on the loan converts to a term loan with amortized principal and interest payments. For more information about this bridge loan, visit compeer.com.

A transitioning grower should take advantage of state and federal assistance programs. Many states have funding available through their departments of agriculture to help pay the costs of organic certification. The USDA Natural Resources Conservation Service (NRCS) offers organic transition payments through its Environmental Quality Incentives Program (EQIP). Every dollar garnered through one of these programs is one less dollar coming out of the farm’s cash flow.

Organic transition is an investment for the farm’s future cash flow. Like any investment, it should be made cautiously and incrementally. Maintaining adequate cash flow and working capital is crucial during the transition years. Spend some time using the OGRAIN Compass to forecast the farm’s financial situation in the years before and after certification, and set up an operating loan if it appears working capital will be short.

In both the public and private sectors, the resources available to help transitioning growers have never been better than they are today. It’s a great time to consider organic grain production.

Paul Dietmann is a senior lending officer at Compeer Financial, a member-owned Farm Credit System institution serving Illinois, Minnesota, and Wisconsin. He is co-author of the book Fearless Farm Finances: Farm Financial Management Demystified .

From the March| April 2020 Issue

 

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