Recently, at an agricultural lending school, a few of the more experienced lenders shared with me a serious issue with which they are currently faced. Many of their producer clients do not know what a balance sheet or income statement is and certainly are not readily able to submit one to the lender. In many past cases, this important paperwork was completed for the producer client by the lender. Other clients present a shoebox full of receipts and expenses expecting it to qualify as acceptable financial records. To summarize, clients often expect the money with as little input as possible and then, presume nothing else will be or should be required.
Wow! It seems agriculture’s recent great commodity super cycle may have skewed the perspective for many producers. High prices, production increases, complacency, and record profits can each easily transport one away from reality. In the past, the lender may have completed the financial records for the borrower in reaction to stiff competition or perhaps, did a simple credit score check before allocating credit. These methods, however, are now history. Lack of complete and accurate financial records is indeed a serious issue; both for the lender and the producer.
Well, this group of producers may be in for a tough transition, similar to 1980s. When an economic cycle is on the positive side, increased profits and money may come easily. However, this can be dangerous. In today’s world, businesses can lose thousands and even millions of dollars very quickly. Often, after these individuals get underwater financially, they then turn to their lender and wonder what went wrong. We are coming into the educational phase of the economic cycle. Organization of financials will be extremely critical.
Recently, I was working with a stressed financial situation. In these situations, the first thing I suggest is to organize business and personal financials. In other words, determine what was spent on the farm and what the household expenses were. Next step should be to develop a simple cash flow and income statement in a computer spreadsheet with a commitment to update monthly. During this process, one important ratio to monitor is the coverage ratio. That is the amount remaining from which to make payments after farm business expenses, living withdrawals, and taxes have been paid. Divide the remaining amount by the payment amount with a goal of 125%.
What is the result of this quick organization of records and financials? Well, this particular farm couple spent one hour with a tax accountant versus three hours as in years prior. They used their savings in time to then, summarize the yearly cash flow and income statement, develop an updated balance sheet with schedules, and submit it to their lender.
After this type of work is completed, the lender has much more confidence in the client’s ability to reliably handle credit. At this point, the lender does leave the client alone. Additionally, the client has a much improved understanding of the business’ financial position as well as any corrective actions that may be needed. Shoebox records and a misplaced dependence on the lender is a recipe for disaster, even with a large amount of equity on the farm balance sheet.
Especially for some, it may be hard to accept this new standard of normal in the lending and banking industry. However, good financial records demonstrate where and how the business can be improved. Regardless of whether or not a producer intends to seek credit, financial records are the foundation for a solid, sustainable business.
PS: Some lenders offer educational opportunities and financial management courses. Get enrolled! In some cases, an interest rate incentive or a cash voucher is offered after successful completion of the course. This should be a mandatory activity for all young producers and spouses and not a bad idea in general, for any individuals involved in agricultural businesses.