With today’s costs of production, the majority of grain and livestock farmers have a need to finance the operational costs of the business. This is in addition to the intermediate expenses such as breeding livestock and/or equipment but also long term debt for land and buildings. Both farmers and lenders take risk when borrowing money and the relationship should involve some key elements to support success for both parties.
Dr. Danny Klinefelter, Professor and Extension Economist at Texas A&M University , suggests that farmers be prepared to borrow based on the framework laid out by the following questions:
- How much money are you going to need? Not just initially, but over a period of time. Lenders don’t want to loan all they feel comfortable with and then suddenly find more is need a short while later.
- What is the money going to be used for? Be specific. Too many operating loans have been used to subsidize lifestyles, refinance and/or pay carryover debt, and finance capital purchases.
- How will the loan affect your financial position? It’s in your best interest to know your net worth, financial structure, historical cash flows, profitability and risk exposure before and after the loan request.
- How will the loan be secured? The important lending consideration is not what collateral is worth at the time of the loan request, but its expected value at the due date or next payment date. Make clear joint ownership arrangements as well as production and equipment contracts and leases.
- How will alternative outcomes affect your repayment ability? The importance of making sound projections and analyzing “what if” scenarios is even more important considering the increased price and yield volatility that producers have to deal with.
- What risk management measures have been implemented? Understand all insurance policies thoroughly by knowing when it will trigger. Grain and livestock marketing is a risk management strategy but incorrect use of futures and options can increase risk and lenders may be unwilling to finance margin calls.
The American Bankers Association says let a farm budget be your financial road map. You are flying in the dark financially if you don’t have a budge for all income and expenses. A farm budget helps you maintain the direction of the business and must be updated frequently. Deal with financial problems or concerns immediately. Farmers and bankers must talk early and often.
Klinefelter further advises a lender’s request for more accurate and complete information should not be viewed as questioning the farmers character; it’s just good business. Being complacent just because your lender has never required all that has been mentioned could prove to be a poor risk management strategy.
OSU Extension can assist farmers in preparing sound financial statements like balance sheets, income statements and cash flows. Contact your local county OSU Extension office.
References:
- Being Prepared to Borrow; Dr. Danny Klinefelter, Texas A&M Univeristy
- Ten Tips for Tough Finacial Times on the Farm; American Bankers Assoication
- A Farmers Guide to Agricultural Credit; Ellinger & Barry, FarmDocs University of Illimois