In our May/June cover story we shared how farmers are making changes to survive low crop prices. Here are three moves you can make to get a clearer picture of your financial situation:
1. Create and share a complete and detailed balance sheet with your lender. Ag bankers need to know it's accurate, so that means they will likely validate some items they see on your balance sheet. They may want to do a farm inspection to check inventories, or call your suppliers about accounts payables.
"If you want to make a banker uncomfortable, present them with an inaccurate balance sheet," says Nate Franzen, ag division president at First Dakota National Bank in Yankton, S.D. "In the long run hiding things will never work out. On the other hand, if we do a validation and determine you're presenting an accurate financial picture, we get more and more comfortable with you as a borrower."
2. Do a financial stress test. Lenders can provide you with great insight to your business through financial analysis. One of those tools is a stress test - in effect, a 'worst case scenario' quiz to see just how your farm would stand up if times got really tough. Look at cash flows and Profit and Loss statements, especially if your operation has been stable without big purchases. Look at 3 to 5 year averages as a starting point. Then start plugging in 'what-if' numbers, and see what happens. Share results with your lender.
"We are going to be doing stress tests on most customers," says Craig Olsen, senior ag banker at Wells Fargo in Lincoln, Neb. "It's a good analysis that needs to happen, especially on grain operations. What happens if you have a 10% decrease in revenue or 10% increase in expenses? What happens if interest rates go up two points? You've got to do those tests just so you know what changes should be made in case they become reality."
Continue reading after the jump >>
The number of farmers concerned about debt is growing. (Source: Farm Futures national survey, March 2015)
3. Figure your repayment capacity. Your debt coverage ratio is net operating income divided by debt service. Lenders use this number to determine your ability to generate enough income in your operation to cover the expense of a debt. When margins slide, so does your debt coverage.
"What you need in the next 12 months is repayment capacity and liquidity," says Virginia Tech ag economist David Kohl. You may need to figure your accrual adjusted income, what lenders call 'true repayment capacity.'
When you get into a loss situation - which some farmers will in 2015 - you have negative debt coverage. That's when your relationship with your lender is most important. You're going to have to tell him or her you don't have earnings to repay debt, so it has to come out of either working capital or through refinanced or restructured loans with extended payments. Just remember, lenders have only so much leeway there.
"If you have a good relationship with your lender and you made recent capital expenditures with cash, such as land or machinery, you may be able to use that equity to restructure and put a loan in place for those prior expenditures, which then boosts your working capital," concludes Franzen.