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Knowledge And Transparency Are Allies In A Bank Meeting

Knowledge is power. We have all heard this phrase, but it is ever so true when it comes to farm finance. The more information we have with regards to our own farm’s financial status, the better armed we are to make good decisions and deal with our banker. Nothing makes a banker’s blood run colder than a customer, or potential customer, sitting across the desk who doesn’t know how their business is doing financially, especially when they’re asking for more financing.

Financial reporting and calculations are some of the most important management tasks, yet very few farm operators spend the necessary time doing them. Finances aren’t sexy and many individuals dislike dealing with the numbers, so they are often ignored, however this part of your business needs attention.

The phrase “work on the business, not in the business” needs to be taken to heart more in agriculture by spending more time managing your business and less time doing the menial jobs. For example, we may pay our accountant $100 an hour to do our financial statements, and our hired man $15 an hour to operate equipment. As a farm manager, is it not better devoting your time to the $100-an-hour job rather than the $15-an-hour one?

Most financial institutions ask for financial statements, or if you are a sole proprietor, they ask for current income tax returns. This is just scratching the surface of financial analysis, as there is much more to what happened on the farm than is reported on those few lines for income tax purposes. Net worth statements, as well as a detailed inventory declaration, will likely be requested from your lender. Be as thorough as possible on these statements — forgotten assets will skew your ratios in a negative way, and forgotten liabilities will be found. If you have “forgotten” to report liabilities, you either have too much debt or are trying to forget about it. Either way, such omissions will be negatively viewed by your lender.

Generally, it is a good idea to drop off your information or fax it to your banker prior to your meeting. This will give them an opportunity to go through your information and be familiar with your operation prior to your meeting. You need to be prepared as well, as you’ll want to spend your meeting talking about the important stuff — your business and your needs — rather than stumbling through your information for the first time.

WHAT YOUR LENDER NEEDS

There are some key financial ratios that your lender will look at in order to renew your loans, or for new financing. There may be others, depending on your sector, but these are some of the key ones. Benchmarks are not included, as different financial institutions and different sectors have varying benchmarks for acceptable ratios.

Net worth is defined as follows: total assets (everything one owns) minus total liabilities (everything one owes). This is often an indicator of what phase a business is in. A mature business will have significant assets and few liabilities, whereas a startup business, where all assets have to be purchased, the majority of which are financed, will show a lower net worth.

Liquidity Ratios are composed of the following:

Current Ratio, which is calculated by dividing current assets by current liabilities. Current assets are assets which will be sold and turned into cash within the next 12 months (such as inventories as grain (excluding seed) and market livestock). Current liabilities are defined as debts that are due within the next 12 months, and includes bills payable to suppliers, operating loans, current portion of long-term debt, etc.

Debt Structure Ratio is calculated by dividing the current debt (debt due within the next 12 months) by total debt (current debt plus long-term debt). This number indicates what percentage of debt is current.

Working capital is calculated by subtracting current liabilities from current assets. This number shows what is left after debt obligations and payables are met within the next 12 months. The working capital ratio indicates funds available to cover other expenses.

Debt to Equity Ratio is calculated by dividing total debt by the total net worth. This ratio indicates how much debt there is compared to available assets. This determines how leveraged the operation is, or how much debt compared to net worth there is.

Profitability ratios indicate return on investment and return to equity.

Debt service coverage ratio (DSCR) indicates how much money is available to pay debt. This is calculated by adding interest and depreciation to the net income, and dividing that number by total payment obligations in the current year (current portion of long-term debt plus interest). For example, if DSCR is 1.25, this indicates that for every $1 of debt obligation due in one year, there will be $1.25 to cover. Debt service coverage ratio is one of the true tests to the question: Can the payments be made?

Many of these calculations are simple to perform, so do them yourself before you go to see your banker. Information is power, and the more you know about your business’s financial status, the better prepared you will be to negotiate for better rates and lower fees.

GETTING THE BEST DEAL

Negotiate you say? Ever wonder why it seems like big business gets all the breaks? This isn’t necessarily true — profitable and low-leveraged businesses get breaks, or maybe a little better deals on financing. Why? It comes down to one thing, and one thing only: risk.

No one likes high risk. We have all heard the saying “high risk, high return,” and this holds true in the financial services industry. If the bank views your operation as high risk (because of poor financial performance in the past, weak ratios, late payment history or other factors) they will expect a higher return by charging you a higher cost of borrowing. So know your numbers: The better they are, the better the deal you will get at the bank.

Once you’ve negotiated the best deal you can get with a lender, you get options: Do you want to have a floating interest rate, or fixed? If it’s fixed, how long of a term do you choose? What will renewal fees be once the term is up? It may seem wise to float your interest rate on shorter-term items, or if you have intentions of paying out the loan early, as there are usually no prepayment penalties on floating rate loans. Over the past few years, floating interest rates have been very low, however there is always the risk of rates climbing.

If you are concerned rates will go up, perhaps you will want to lock in some loans, or fix the rate. Ask the questions: What are prepayment penalties if I want to pay it out early? What will renewal fees be when the loan term is up and I have to renew?

On large loans, it can pay to float a portion and fix a portion. That way if rates climb quickly, the fixed portion will be locked in, however if rates decrease, the floating portion will be more favour-able. Ask your lender to prepare a cost of borrowing analysis for you with a few different interest rate options in order to make a good decision.

Obtaining credit has become slightly more difficult over the past few years as broader economic conditions have made the financial services industry nervous. However, with good business practices partnered with good financial reporting and analysis, credit is still readily available to those who are deemed risk-worthy. Know your numbers, be transparent with your lender and work with your bank. If your business is in trouble, don’t wait for your banker to tell you so, know so yourself, and take steps to rectify it. If you need help to get your financials on track, find a consultant in your area who can get you started and help you understand your numbers and take appropriate steps to turn things around.

MaureenMappin-Smith,B.Sc.Ag.,wasan agriculturallenderforseveralyears.She nowworkswithCAFA,andfarmswithher husbandandparentsineast-centralAlberta. Contactherat [email protected]

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Know your numbers. The better they are, the better the deal you will get at the bank

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