Two simulated farm case studies provide a means for teaching financial and risk management strategies to western Kentucky grain farmers. Aggregate financial data for 227 grain farms define the case studies, which illustrate how cost and debt affect cash flow and working capital over a 5-year period. Responding to the case studies, farmers were able to discuss these financial concepts in a group setting among competitor neighbors without revealing personal business information. The use of composite financial data engaged the farmers and allowed for improved discussion on risk management products and the potential to protect working capital over multiple years. Extension professionals can apply the methods described

Davis, Todd D.

Mark, Tyler B.

Shepherd, Johnathan D.

English

Clemson University: TigerPrints

Journal of Extension Volume 56 Number 1 Article 5 2-1-2018 Using Simulated Farm Case Studies to Teach Financial and Risk Management Concepts Todd D. Davis University of Kentucky Tyler B. Mark University of Kentucky Johnathan D. Shepherd University of Kentucky Recommended Citation Davis, T. D., Mark, T. B., & Shepherd, J. D. (2018). Using Simulated Farm Case Studies to Teach Financial and Risk Management Concepts. Journal of Extension, 56(1), Article 5. https://tigerprints.clemson.edu/joe/vol56/iss1/5 This Tools of the Trade is brought to you for free and open access by TigerPrints. It has been accepted for inclusion in Journal of Extension by an authorized editor of TigerPrints. For more information, please contact kokeefe@clemson.edu. February 2018Volume 56Number 1Article # 1TOT1Tools of the TradeUsing Simulated Farm Case Studies to Teach Financial and RiskManagement ConceptsAbstractTwo simulated farm case studies provide a means for teaching financial and risk management strategies to westernKentucky grain farmers. Aggregate financial data for 227 grain farms define the case studies, which illustrate howcost and debt affect cash flow and working capital over a 5-year period. Responding to the case studies, farmerswere able to discuss these financial concepts in a group setting among competitor neighbors without revealingpersonal business information. The use of composite financial data engaged the farmers and allowed for improveddiscussion on risk management products and the potential to protect working capital over multiple years. Extensionprofessionals can apply the methods described.Keywords: farm case studies, risk management, cost, debt, liquidity  IntroductionTeaching financial and risk management concepts to farmers is challenging as the best strategy depends oncomparing unique cost structure, debt level, family living expense, and available working capital data to price,yield, financial risk, and the individual farmer's risk tolerance. Consequently, Extension management educationalprograms often involve the use of decision aids that provide farmers with a range of outcomes. Farmers thendetermine where they are on a continuum of possible cost structures and debt levels to choose the best strategy.A second issue related to delivering precise financial and risk management education is that farmers can behesitant to disclose cash rental rates, machinery costs, and family living expenses in a group setting. Onestrategy for circumventing this hesitance is to use case studies. For example, Barnard (1996) used a case studyto teach financial statements in a workshop setting and reported that students experienced an engaged learningenvironment. Building on Barnard's methodology, we developed simulated farm case studies from real aggregatefarm-level data and used those case studies to teach financial and risk management concepts to grain farmersand agricultural lenders in a workshop setting.Development and Use of Simulated Farm Case StudiesTodd D. DavisAssistant ExtensionProfessorUniversity of KentuckyPrinceton, Kentuckytodd.davis@uky.eduTyler B. MarkAssistant ProfessorUniversity of KentuckyLexington, Kentuckytyler.mark@uky.eduJohnathan D.ShepherdKentucky FarmBusiness ManagementSpecialistUniversity of KentuckyLexington, Kentuckyjdshepherd@uky.eduKentucky Farm Business Management program data summarizing 227 grain farms (Jenkins, 2015) were thesource for our simulated farm case studies. The two case studies represent a low-cost/low-debt (LCLD) grainoperation and a high-cost/high-debt (HCHD) grain operation. These farms bookend a continuum of possible costand debt structures. In using the case studies to discuss scenarios with farmers, our assumptions includedidentical production variables for both farms andidentical acreage, crop mix, yields, and market prices.We kept these variables constant to focus the discussion on managing cost, debt, and working capital.The financial and risk management model we used with the case studies simulated each farm business's cashflow for 2016 to 2020. The cash flow included production costs, land rent, overhead expenses, family livingwithdrawals, principal and interest payments for the operating note, and principal and interest due onintermediate and long-term debt. Figure 1 shows how the model addressed cash flow deficits. According to themodel, if the farm business had a deficit, the farmer's first step would be to increase operating note borrowing tomanage the deficit. Following that step, the farmer would use cash to pay any deficit remaining after reaching theoperating debt limit and then income from additional grain sales to pay any deficit remaining after using debt andcash. The model stopped if the farm's working capital was exhausted, and we asked the audience to suggestmanagerial alternatives for dealing with remaining cash flow problems. Suggestions included selling intermediateor long-term assets, liquidating personal retirement accounts, and converting current debt to long-term debt.Figure 1.Simulated Farm Deficit Management StrategyTools of the Trade Using Simulated Farm Case Studies to Teach Financial and Risk Management Concepts JOE 56(1)©2018 Extension Journal Inc 1Benefits of Using Simulated Farm Case Studies in ExtensionEducationThe case studies engaged farmers in a nonthreatening and less personal discussion. Farmers could discuss riskmanagement strategies without revealing to potential rivals their own cost structures, debt levels, or amountsspent on family living. Farmers used Turning Point clickers to answer questions anonymously about possiblemanagerial solutions to problems illustrated by the case studies.The farm case studies have specific financial and risk management lessons embedded in their design. Theworkshop focus was on managing cost, debt, and working capital and using appropriate risk management toolsfor the 2016 crop year. The two extreme farm case studies illustrated that risk management is farm and farmerdependent. The ideal risk management plan depends on the farmer's willingness to accept the risk of a cash flowdeficit. Some farmers may use risk management tools to reduce the risk of maximizing operating credit orliquidating cash and grain reserves.The simulated farm case studies illustrate the interaction between risk management tools and a farm's financialposition. Many Extension programs do not address the complementary effects of combining risk tools to protectrevenue. The effects of risk management on a farm's finances are not taught in Extension meetings. As manygrain farms in western Kentucky have cash flow problems instead of debt, workshop emphasis was on ensuringthat farmers understood the risk management tools available for preserving working capital over a multiyearperiod.Discussion Generated by Simulated Farm Case StudiesThe HCHD farm exhausted working capital before the end of the 5-year simulation. The resulting discussioncentered on modifying cash rental rates, machinery costs, and family living expenses to reduce cost structure.Farmers discussed whether paying a premium for marginal ground is worth the benefit of reducing fixed costs.Many farmers indicated fearing that they might never have the opportunity to rent the ground again as otherscould be willing to pay higher rental rates. Farmers noted that landowners are less sympathetic about reducingcash rental rates for farmers who have not reduced family living expenses.The machinery cost discussion alerted farmers to the tax consequences of selling machinery written off underSection 179 expensing. Specialists involved in the workshops also reminded farmers that reducing machinerycapacity might slow the timeliness of planting and harvesting, resulting in yield penalties and lower profitability.The final discussion point was family living expenses. The average family living expense in 2014 was $108,550(Pierce, 2016). The consensus was that reducing family living expenses is difficult because reductions are likely tocause stress as family members have to sacrifice more than in previous years.Additional discussion focused on risk protection. The farm case studies illustrated the risk protection provided byrevenue protection crop insurance, hedging with futures, put options, and forward contracts for the 2016 cropyear. The farm case studies also illustrated the risk protection provided by combining these risk managementtools for both the LCLD and HCHD farms.Lessons Learned and Suggestions for the FutureOne lesson we learned is that agricultural lenders should be involved in creating the case studies andTools of the Trade Using Simulated Farm Case Studies to Teach Financial and Risk Management Concepts JOE 56(1)©2018 Extension Journal Inc 2participating in the workshop discussions. Another is that discussions should be oriented specifically towardbeginning farmers. These farmers may have higher debt and higher costs than more established farmers.Additionally, beginning farmers who have not experienced commodity cycles may have unrealistic expectations offarm profitability and use of risk management tools to protect revenue risk.In a future version of the financial and risk management educational programming, we will use the KentuckyFarm Business Management data to develop case studies of farms with top-third, middle-third, and lowest-thirdprofitability levels to provide further detail regarding the continuum of cost structures and debt facing westernKentucky grain farmers. In general, Extension specialists working with farmers elsewhere can apply thesimulated-farm-case-studies method to teach financial management and risk management concepts and engagefarmers without asking for personal financial information.ReferencesBarnard, F. L. (1996). PASSing the Financial Management Interest Exam. Journal of Extension, 34(4), Article4TOT1. Available at: https://www.joe.org/joe/1996august/tt1.phpJenkins, A. (2015). Annual summary data—Kentucky grain farms—2014. Retrieved fromhttp://www.uky.edu/Ag/AgEcon/pubs/kfbmkfbmsumgr201410.pdfPierce, J. S. Jr. (2016). Preliminary grain analysis summary. Retrieved fromhttp://www.uky.edu/Ag/AgEcon/pubs/extkfbmsumdata1627.pdfCopyright © by Extension Journal, Inc. ISSN 1077-5315. Articles appearing in the Journal become the property ofthe Journal. Single copies of articles may be reproduced in electronic or print form for use in educational ortraining activities. Inclusion of articles in other publications, electronic sources, or systematic large-scaledistribution may be done only with prior electronic or written permission of the Journal Editorial Office, joe-ed@joe.org.If you have difficulties viewing or printing this page, please contact JOE Technical SupportTools of the Trade Using Simulated Farm Case Studies to Teach Financial and Risk Management Concepts JOE 56(1)©2018 Extension Journal Inc 3

Using Simulated Farm Case Studies to Teach Financial and Risk Management Concepts

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Using Simulated Farm Case Studies to Teach Financial and Risk Management Concepts

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