Being Prepared to Borrow
Twelve questions to ask yourself before you meet your lender
Compiled by staff
Published: Dec 22, 2010
Note: This article was prepared by Danny Klinefelter, agricultural economist, Texas A&M University.
Given the size and capital intensity of today's commercial farms and ranches, it is virtually impossible to operate the business or to grow without using credit. But the changing structure of the agricultural lending industry along with the greater importance of risk management is going to make the credit acquisition process increasingly rigorous for agricultural producers.
To help you be better prepared, the following twelve questions lay out a framework for developing the documentation needed in a loan package.
1. How much are you going to need? Not just initially, but over the period of and for the purpose of the loan request. Lenders don't want to loan all they feel comfortable with and then suddenly find they need to loan significantly more in order to see the situation through to completion..
2. What is the money going to be used for? Be specific. It's not enough to say "operating expenses." In the past, too many operating loans have been used to subsidize lifestyles, refinance and/or pay carryover debt, and finance capital purchases. Plans need to be supported not just by budgets, but by historical documentation showing that they reflect past experience.
3. How will the loan affect your financial position? It is obviously important to know what your net worth, financial structure, historical cash flows, profitability and risk exposure are at the time of the loan request, but what will things look like after the loan is made?
4. How will the loan be secured? You need to recognize that collateral is adequate only if, under the worst conditions, enough could be collected to generate sufficient cash to repay the loan and cover all the costs involved. Except for control purposes, the primary purpose of collateral is to provide insurance in the event of default.
5. How will the loan be repaid? Will it be from operating profits, from non-farm income, from the sale of the asset being financed, from refinancing or from the liquidation of other assets?
6. When will the money be needed and when will it be repaid? This two-part question should be answered with a projected cash flow budget. Answering this question makes sure both you and the lender know how the business operates. Almost as many credit problems have resulted from a lack of understanding and communication, as have resulted from unrealistic expectations.
7. Are your projections reasonable and supported by documented historical information? Too many producers still do not have the production, marketing and financial records to demonstrate their track record and support their numbers. Many loans have not been made that probably could have been repaid simply because of a borrower's inability or unwillingness to provide the lender with complete and well documented historical information.
8. How will alternative possible outcomes affect your repayment ability? Due to the numerous factors affecting production agriculture, cash flow projections frequently vary from the actual outcome – especially on the revenue side. 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.
9. How will you repay the loan if the first repayment plan fails? No commercial lender wants to enter into a situation in which foreclosure is the only alternative if things do not go as planned. Contingency planning is critical.
10. How much can you afford to lose and still maintain a viable operation? There are several factors to consider here. The first is to recognize that a viable net worth is not anything above zero. Most commercial lenders require some minimum equity position, e.g. 30%, below which they will not continue financing without an external guarantee. With this in mind, the answer to the question must be based on the effect of various combinations of both potential operating losses and declines in asset values.
11. What risk management measures have been implemented? This can cover anything from formal risk management tools to management strategies. The major issue here is to make absolutely sure that both the borrower and the lender understand how these measures work.
12. What have been the trends in the business's key financial position and performance indicators? The first issue is, do you know? The second is, if the trends are adverse, what are the specific short-and long-term plans for turning things around?
Permalink: Click here
Tagged: SURE, farm, insurance, ranches
|