Before going to the bank to talk loans, it’s important consider the implications and ramifications.
“Farming is a capital intensive business,” says Rick Dehod, farm financial specialist, Agriculture and Forestry, Edmonton. “In order to meet the goals of the business, most farms will lever their equity so that they can manage their businesses to provide their families with a reasonable standard of living. They also seek to increase their equity so that they’re better able to manage risk. It’s the use of business equity in efficient manner that’ll allow the farm business to access credit from the bank.”
Dehod says there are five questions producers should be able to answer to themselves and to their business partners before seeking financing.
What are you going to do with the money?
“First off, do you have a clear plan of what you are going to do with the money? Is it for operating, is it to buy land (how many acres, what buildings) or machinery (new or used)? How does this relate back to your business plan and overall farm investment strategy? Is your goal to expand, stay current with evolving technology, or just continue to operate? Is it a business decision or an emotional decision? Are your business partners in agreement? Does the potential return on equity by levering borrowed capital meet your goals and objectives?”
How much do you want?
Dehod says it’s important to decide how much cash and how much borrowed money is needed. “Using all your cash will impact your farm’s liquidity and possibly its ability to meet all of your commitments as they come due. Large payments on borrowed capital can affect your working capital position and your ability to manage risk. How much of your current equity are you willing to put at risk?”
How long do you want the money for?
“Look at the loan amortization length, and resulting loan payments to see if the payments meet your cash flow and your ownership goals. A longer loan amortization with a prepayment privilege may provide less stress on cash flow should margins tighten. Agriculture markets are cyclical.”
How are you going to repay the money?
Can the farm service the additional debt? “Your past income and expenses is a good benchmark to determine your future repayment ability,” says Dehod. “Using this as a base, you can do a projection of what your future income and expenses will be and what your debt service requirement can be. Doing a sensitivity analysis by decreasing your income 10 per cent and increasing your expenses by 10 per cent will give you an indication of your repayment risk and your ability to make your payments, should things go not as planned.”
What are the alternative sources of repayment in the event of something going wrong?
“Life happens. People have accidents or illnesses that make them unable to manage their farms on a timely basis. People divorce. This is a stressful issue not only on the focus of managing the business but on the financial resources of the business, should the assets be split. Agriculture is a risk business. Weather can’t be controlled but can be managed. Agricultural markets fluctuate. All of these can affect the farms ability to generate the revenue required to make its payments and meet all of its commitments. What is your risk mitigating strategies should any of these events happen? We can’t foresee everything, but we can plan to manage life’s risks.”
Source : Agriculture and Forestry