Before going to the bank to discuss a new loan, it is important to consider the implications and ramifications. Joel Bokenfohr, agricultural business and policy analyst with Alberta Agriculture and Forestry, explains those considerations.
“Farming is a capital intensive business,” says Bokenfohr. “In order to meet the goals of the business, most farms will lever their equity so they can manage their businesses and provide their families with a reasonable standard of living. They also seek to increase their equity so they are better able to manage risk. It is the use of business equity in an efficient manner that will allow the farm business to access credit from the bank. Every farmer has a different risk tolerance level and comfort with debt. It is important to consider these factors when looking at a new loan.”
Bokenfohr says there are five questions producers should be able to answer for themselves and for their business partners before seeking financing.
How does this loan fit with your business plan?
“First off, do you have a clear plan of what you are going to do with the money? Is it for operating, to buy land (how many acres, what buildings), or machinery (new or used)? How does it relate back to your business plan and overall farm investment strategy? Is your goal to expand, bring in a new partner, stay current with evolving technology, or just continue to operate? Is it a business decision or an emotional decision? Are your business partners and family in agreement? Consider how the potential return on the investment will meet your goals and objectives in the long term.”
How much do you want?
Bokenfohr says it is important to decide how much cash and how much borrowed money is needed. “Using all your cash flow on a new purchase will impact your farm’s liquidity, and possibly its ability to meet other commitments as payments come due. Large payments on borrowed capital can affect your working capital position and your ability to manage risk. Consider how much of your current equity you’re willing to risk on a new loan.”
For how long do you want the money?
“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 or allow you to contribute more if margins improve.”
How are you going to repay the money?
Can the farm service the additional debt? “Your past income and expenses are good benchmarks to determine your future repayment ability,” says Bokenfohr. “Using this as a base, you can project 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. It is a stressful issue that not only focuses on managing the business, but on the financial resources of the business, and whether the assets be split. Agriculture is a risk business. Weather can’t be controlled but can be managed. Plus, agricultural markets fluctuate. These factors can affect the farm’s ability to generate the revenue required to make payments and meet all commitments. You can’t anticipate all the potential risks, but developing a risk strategy before accessing debt can go a long way in mitigating consequences.”
Source : Alberta Ag and Forestry