[EDITOR’S NOTE – Our Ag Finance column this month comes from Zack Purvis, Chief Lending Officer of AgGeorgia Farm Credit, part of the nationwide Farm Credit system.We welcome your questions about ag finance – just address them to email@example.com and look for the answers here.]
Farming is an expensive business. Equipment, seed, fertilizer, real estate, labor…and the list goes on. You’ll likely need to borrow money at some point to fund these expenses, and understanding what your lender looks at when considering your loan request will help you get the capital you need to operate your business.
One of the first things we teach a new lender at Farm Credit is the “Five C’s of Credit.” Character, Conditions, Capital, Capacity, and Collateral. Since these are the criteria your prospective lender is using to determine whether to make you a loan (and on what terms), you’ll be in a much better position if you understand where you stand in these areas and are ready to discuss them with your loan officer.
This is the most difficult of the Five C’s to quantify, but probably the most important when times get tough. A few areas your loan officer will consider are: repayment history with them; history with other creditors; reputation in the community; financial record-keeping; and how well you understand the risks in your operation.
There are two fairly easy steps you can take to boost your standing relative to this “C.” First, order a credit report (for free) on yourself prior to meeting with your loan officer. You can do this at annualcreditreport.com or directly from any of the three major credit bureaus (Equifax, TransUnion, and Experian).
If there are any blemishes on your report – late payments, collections, judgments, tax liens, etc. – either work with the provider to get any incorrect items cleaned up or be ready to discuss with your loan officer at your first meeting.
Second, take the time to organize your financial records and crop plan into a professional package. I have made loans to farmers that used the back of an envelope to maintain their records, but the farmers that were willing to invest time in maintaining their financial records usually got the best terms and the process was always smoother for everyone involved.
The second “C” concerns the conditions in your industry and how your operation fits in. Agriculture is a volatile business and tends to run in cycles, so your lender is concerned with the future outlook for your part of the industry and how prepared your operation is to survive and thrive.
For instance, if conditions have been poor for a few years but you have maintained a reasonable financial position, your lender feels more comfortable in your management ability and willingness to stay conservative in the good times because you know things will be tighter sometime down the road.
To be prepared to discuss this “C” with your loan officer, think about where in the “cycle” your industry is and be ready to tell them how this is affecting your operation. If times are good, tell the lender how you’re preparing for the inevitable downturn. If times are tough, show them where you’re cutting back and what changes you’re making to keep your business profitable.
The primary document used to assess this “C” is a balance sheet. Balance sheets are just a listing of everything you own and everything you owe. If you haven’t completed a balance sheet for yourself and/or your business, I highly encourage you to do it whether you’re planning to seek a loan anytime soon or not. There are tons of templates online (I just googled “balance sheet template” and it returned over 2 million results).
When a lender is reviewing your balance sheet, they are assessing your ability to “weather the storm.” It’s inevitable that things will not always go as planned, and your loan officer wants to be sure there is enough equity and liquidity in your operation to withstand adversity.
Equity is simply a measure of what you own minus what you owe. The more debt you owe (loans, open accounts, etc.) compared to your assets, the harder it will be for you to withstand much adversity. If most of your assets were not financed with debt, you’ll be in a better position to stretch out repayment terms or make other agreements with your loan officer to make it through the tough times.
Concerning liquidity, this is a measure of your shortest-term assets and liabilities. Assets included would be items like cash, marketable securities, and crops on hand. Short-term liabilities are anything you have to repay over the next year (operating loans, open accounts, term debt payments, etc.).
Shoot for always having your short-term assets exceed short-term liabilities. The more these assets exceed their corresponding liabilities, the more comfortable your lender will be providing you the best terms for a loan.
Capacity measures your ability to service all your financial obligations. This includes repaying your operating loan, any term debt payments, open accounts with vendors, taxes, and family living expenses. The best way to prepare for addressing this “C” is to make a detailed list with the following items to discuss with your loan officer.
- Conservative projection of revenues (crop sales, non-farm income, etc.)
- Operating Expenses (crop inputs, labor, land rent, fuel, etc.)
- Taxes (income, property, etc.)
- Family Living Expenses
- Funds Available to Service Debt
To leave room for adverse events during the year, it’s best to have Funds Available to Service Debt at least 1.25 times the amount of term debt payments you have coming due in the next year.
Lenders have no “upside” in a loan transaction. The best a lender can do is when the loan is repaid on time with interest. We hope you do extraordinarily well and make lots of money, but any of that “upside” goes to you. Because of this, your lender has to protect the “downside.”
That’s where collateral comes in. Collateral protects the lender from losing too much money if things don’t work out well. The collateral required for a loan is very dependent on the specifics of your loan request, but be prepared to discuss what you’re able to offer early on in your discussions with the lender and provide as much detail and documentation as you can about the value and condition of the collateral offered.
If you’ll think through the Five C’s of your operation before meeting with a lender, you’ll be in a much better position to receive the capital you need on the best possible terms. Or better yet, address them all in writing and provide them to your loan officer with the loan request.
After your loan officer gets up off the floor and quits seeing stars, I promise you will have their undivided attention toward getting you the capital you need to run a successful farm business.
To find out about the Farm Credit association that serves you and get information on financing for everything from land purchases to home construction to farm improvements and operating expenses, visit FarmCredit.com.