As a farmer and business owner, sometimes it can feel like your banker speaks another language. When you’re applying for a loan to build a new barn or buy a new tractor, there are a few key aspects you can focus on to ensure you make the best decisions for your business and achieve the best lending rates.
Management skills and financial health are two vital aspects of any successful business.
While getting a lower lending rate is great, the main reason to improve these aspects is to build a successful and sustainable business.
What does the bank look for when it comes to management?
A plan: The bank wants to see that you have a plan, and they want to see that you stick to your plan and produce results. The more you can do to show your account manager that you have done your homework (e.g. an annual business plan, an annual crop budget), the better.
Information management: Keeping good records to show your financial position and know your cost of production is one of the best ways you can prove your management skills. Not only that, understanding these aspects of your business is crucial to success. Examples of good information management are keeping frequent, up-to-date financial statements as well as integrating your production and financial data. Try to track performance indicators like feed conversion and crop yields.
Risk mitigation: We all know that markets aren’t always predictable, so it’s in your best interest to make use of risk management tools. Some of these tools include crop insurance and strategies such as diversification, hedging and forward contracting. Risk mitigation helps protect the business you’ve built, but also makes you a better manager in the eyes of your lender.
What does the bank look for in my financials?
While the bank digs a little deeper than just the ratios below, here are a few common indicators that are analyzed for agricultural lending:
Debt service coverage:Debt service coverage is your ability to pay principle and interest for the year based on EBITDA (earnings before interest, taxes, depreciation and amortization). If you earn $100,000 a year before deducting interest, taxes, depreciation and amortization, and your principle and interest payments for the year are $50,000, you have debt service coverage of 2:1.
Debt service coverage is important because it shows that earnings are sufficient to pay down debt. It tells you whether or not you can afford to make payments towards new investments on the farm.
Debt to net worth ratio: How does your debt load stack up against your worth? Lower debt compared to net worth indicates you have plenty of assets to cover your liabilities. To calculate how the two compare, divide your total debt by your total net worth. If for some reason you decide to exit the market, it is important that you are able to cover your liabilities, for your own sake and that of your creditors.
Debt to EBITDA ratio:This ratio tells you roughly how many years it would take to pay down the debt. To calculate it, divide your total debt by your EBITDA. This is important because it shows that your business can handle the debt load and whether or not you could manage more debt to fund growth.
Current ratio: The current ratio is calculated as current assets divided by current liabilities. Also called the working capital ratio, it indicates the amount of current assets relative to short-term debt. The current ratio gives a good picture of financial health because it shows your business’s ability to pay creditors. If the current ratio is greater than 1, this shows that currents assets are available to cover accounts payable to suppliers and other short-term debt. This ratio is especially important to non-supply-managed farmers because strong working capital provides a safety net against volatile markets and the ups and downs of production cycles.
To sum it all up: Create a plan, keep good records to measure progress and try to mitigate any risks associated with your business. At the end of the day your account manager is here to work with you as you grow your business and add value through financial advice. Your account manager can point you in the right direction to improve these ratios and help you implement systems to improve your management capabilities.