The Road Warrior stopped in Spearfish, SD, this summer for the agribankers school at Black Hills State University. A perceptive agri-lender from Oklahoma forwarded an interesting concept: financial numbers that producers can remember away from the office, or out on their tractor or combine. The following is a list of a few compiled by the class.
50% DEBT-TO-ASSET RATIO
If you are a grain producer, exceeding this level requires very astute management and a frugal living style. If your operation is diversified or you are just beginning, higher degrees of financial leverage are acceptable, but they may come with higher interest rates and stricter covenants in the loan agreement to cover risk. Remember: The No. 1 financial factor that predicted financial stress in a farm or ranch business in the 1980s was a debt-to-asset ratio exceeding 50%.
WORKING CAPITAL EXCEEDING 15% OF REVENUE OR EXPENSES
Throw out the current ratio and bring on the working capital ratio. Subtract current liabilities from current assets to get working capital, then divide the result by your revenue or expenses. In today's volatile times, maintain 15% as a guideline. To be on the safe side, maintain 15-33%. If you are conservative or desire flexibility, maintain levels above 33%. Warning: Grain producers' working capital metrics need to be increasing in the current environment.
700 CREDIT SCORE
Whether you are applying for credit with John Deere, Farm Credit, the local bank or another lending institution, you need to know your credit score like your collateral level or pulse rate. As a guideline, people with a credit score above 700 pose low credit risk. A score above 800 represents less than a 1% chance of delinquency, while above 700 corresponds to a 5% chance of delinquency.
The average credit score in the U.S. ranges from 694 to 697. A score below 650 will require the agri-lender to scrutinize your credit report and financials carefully. Your spouse's score is also often requested. Lenders in today's financially stressed environment will usually average the applicant and spouse's scores, or make a decision based on the lower of the two scores. These scores are used for insurance and employment screening, too.
5 DIFFERENT CREDIT SOURCES
This was the battle cry of a stressed agricultural credit in the 1980s. Split lines of credit — particularly more than five different sources — are often considered a red flag in credit risk. All too often, a producer would rob Peter to pay Paul, which is not sustainable in the long run.
75¢ to $1
Take your expenses and deduct interest and depreciation. Divide the result by total revenue. If you have 75¢ of expenses for every $1 of income generated, you are average. Less than 68¢ of expenses per $1 of income places you in the top 20% of profit managers. If your business is a corporation, also subtract corporate salary in forming the ratio.
Keep these guidelines in mind as you are away from the office this fall.
Dave Kohl, Corn & Soybean Digest trends editor, is professor emeritus at Virginia Tech. He's published four books and over 500 articles on financial and business topics. You can reach him at [email protected].