Farming businesses rarely generate adequate operating profits in a timely manner to fund all its capital needs, which include interest payments, owner demands, term debt payments, and asset replacements of static farming businesses, and it’s especially true of expanding farm businesses.
Whether your farm is expanding or just working to profitably maintain its current level of operation, agricultural loans are one source of funding available to help you reach your goals. Before you approach the lender and for certain before you sign, make sure you can answer the following questions:
1. What is the purpose of the loan?
Will you use the funds for land, equipment, operations, loan restructuring, or creating a new business entity? Being clear about the purpose of your loan helps ensure that you understand how you will use the funds to meet specific goals for your farm business. Additionally, different repayment terms will be appropriate depending on what the loan will fund.
2. What is the best lender for your needs?
If you have a preexisting relationship with a lender, you may decide to work with them again. Before you make a final decision, however, make sure you’re aware of what other lenders have to offer. Compare variables such as the loan terms, interest rates, and loan limits offered by different lenders, so you can choose the most beneficial option for your farm.
3. What is the state of your business solvency?
To understand the answer to this question, it’s important to know your debt-to-asset and equity-to-asset ratios. You’ll also need this information for the loan application—as well as the pro forma status of your farm after loan approval.
4. How is your business liquidity?
This assessment should include your current ratio (calculated by dividing current assets by current liabilities), working capital (current assets minus current liabilities), and the ratio of working capital to gross revenue. Know both your present numbers and your farm’s pro forma status after loan approval.
5. What was your farm’s profitability for the most current year and the previous five years?
Preferably, you’ll be able to support this answer not only with your annual tax returns (which are most likely calculated on a cash basis) but also with annual accrual profit-and-loss reporting. Understand your farm’s level of profitability, profitability trends, and how volatile or consistent profitability is as well as the rate of returns on farm assets and equity.
6. What is your repayment capacity?
Develop an operating budget and capital budget that display the impact of the loan on profitability and the capacity of the cash flow to meet the loan’s principal and interest payment schedule.
7. Do the loan terms include prepayment penalties?
Before signing, know (or, if necessary, negotiate) the impact of paying the loan off early relative to the original loan schedule. If no prepayment penalties are involved in your loan, make sure to avoid damaging your farm’s working capital position in the event you decide to make early payments.
8. Do you understand all loan covenants?
Make sure you understand any requirements that you must maintain (e.g., a specific level of year-end working capital) in order to keep your loan in good standing. Failure to meet such covenants can put you in default. If possible, negotiate any covenants that will be included.
9. Your business’s timeline or legacy?
Depending on the magnitude or scope of the loan and its purpose, are the age(s) of the owner(s) and the comfort level of the owner(s) in agreement with moving forward with the plan of action?
10. Stakeholders’ involvement?
This may already be a given as perhaps all stakeholders’ signatures may be required on loan documents. Regardless, be certain that all stakeholders in the business are aware and knowledgeable regarding the purpose of the loan(s) and each of the considerations indicated above.
If you can use some help understanding all of the financial considerations involved in making loan decisions or believe your farm operation could benefit from agricultural financial consulting, contact the experts at AgriSolutions. We can start with a free consultation, where we’ll gain an understanding of your financial management needs and let you know how we can help.
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