What is Forest Finance?

According to Forest Finance Simplified, forest finance “is the language and analysis of managing forest resources as investments.” For investors and businesses, the value of a forest is determined by the returns on the capital committed to owning, growing, and marketing the trees. In forestry, financial analysis supports decisions such as the optimal rotation, silvicultural strategies, and the buying and selling of timberlands.

Forestry and Finance

Financial analysis depends on two economic concepts. One, we prefer more money rather than less. Two, we prefer dollars today rather than dollars tomorrow. In forest finance, these concepts encourage us to maximize net present value (bigger is better) and invest in forest management that shortens rotations (time value of money). They remind us to always consider the opportunity cost of putting capital into forests versus our next best investment alternative.

Basic financial tools and frameworks help organize our thinking to make optimal decisions given what we know at the time. As forestry pioneer and educator Carl Schenck wrote years ago:

“No capitalist and no forester is forced to adopt a financial formula or equation when determining the merits of an investment. The equation merely illustrates a logical manner of financial thinking….”

Forest finance and financial analysis provide forest owners and investors with methods for selecting the best option given their objectives. It addresses the question, “What approaches can we use to screen, value, and rank potential forestry investments?”

Asking Questions and Applying Frameworks to Make Decisions

With a few questions, we can assess the ability and competitiveness of any investor seeking to buy or sell timberland in each business environment. Key elements in the math of investing represent levers over which different investors have varying levels of flexibility.

For example, consider the roles of discount rates and time horizons as either enabling or constraining investor valuation efforts. Discount rates refer to risk and asks, “what is the appropriate hurdle rate or expected return for this asset and opportunity?” Time can refer to either the length of the expected investment – “what is the investment period?” – or the timing – “when?” – of a potential investment decision.

A corporation may have zero flexibility with the discount rate because they have a hurdle rate mandated by the Board of Directors. An institutional investor may have some flexibility with the discount rate, but little room to adjust timing, as they need a project of exactly 10 or 20 years. Differences across objectives, such as cash flows versus value preservation, affect the competitiveness of different investors looking at the same timberland properties.

In forestry and the Applied Forest Finance course, we organize fundamental investment questions into four categories:

1. Accept/Reject: Does this project or investment satisfy our rate of return or opportunity cost expectations?
2. Rank/Prioritize: Of the qualifying projects or investments, which should we choose or consider further?
3. Value/Valuation: What is this asset worth?
4. Optimize: How do we maximize the value of the asset we own?

When deciding where to allocate limited capital, we benefit by systematically applying criteria for identifying, ranking, and optimizing the available options. Choosing which criterion to use depends on the question we’re asking.

For a range of objectives, finance represents a tradeoff between today and tomorrow. To paraphrase forest economist David Wear of the U.S. Forest Service, an investment is the dedication of today’s resources to tomorrow’s production. Investing in something now – a factory, research, or timberland – means giving something today to gain in the future. The tools of finance help us evaluate the tradeoffs and assess whether each forest investment opportunity meets our objectives.