There are many different types of contracts that can be used to sell grain. One of them is a deferred price contract, also known as a credit sale contract. These contracts are different from cash and forward-priced contracts because they create a unique relationship between the two parties: The seller becomes an unsecured creditor of the buyer.
“Deferred price contracts are marketing tools producers have available to them, but there are risks that need to be understood,” says Keri Jacobs, assistant professor and Extension economist at Iowa State University. “With these contract types, there may be a delivery component or price component that is left open. Because ownership of the grain might be assigned to a company but the price and payment for it comes later, the credit worthiness of the company you are doing business with needs to be established.”
Evaluating buyer’s financial position
Because of additional risk to the seller, farmers who are thinking of using deferred price contracts should carefully evaluate the financial position of firms they would be entering into an agreement with, she advises. The type of information sellers should be looking for is highlighted in Jacobs’ new ISU Extension publication, “Evaluating a Company’s Financial Position before Selling Grain on Deferred Price Contracts,” FMR 1893.
“Typically there are a lot of questions about pricing components and price risk of this type of contract, but not about the credit risk,” Jacobs says. “If a producer sells grain on this type of contract, they become an unsecured creditor. If the company they sold to goes bankrupt or can’t pay, the producer no longer controls the grain and may be last in line for settlement, behind secured creditors such as banks. Our new publication aims to help producers understand that part of their responsibility before entering into this type of contract is to make sure the firm they do business with is financially secure.”
Key considerations when evaluating company
There are several key financial indicators to think about when evaluating a company’s financial position. These include their working capital, ratio of working capital to sales, leverage, ratio of term debt to net fixed assets, and their profits.
“Liquidity is probably the most important factor when trying to understand the short-term financial stability of a company,” Jacobs notes. “Their working capital provides the most information about short-term cash, inventory levels and what liabilities are against them. Can their current debts be met with their available liquid assets?”
Each indicator is examined, using examples and sample balance and statement sheets to help demonstrate how to evaluate a company’s financial position. A farmer can more confidently enter into a deferred price contract when they are satisfied with the financial position of the company they are selling to, Jacobs says. Her new publication was peer-reviewed by two independent reviewers using a double-blind process.
Source: Iowa State University