How To Obtain and Use Agricultural Credit in the 1990's

Sound use of agricultural credit is a two-way street affecting both borrower and lender. At times it may seem to the borrower like walking a tightrope. The individual seeking credit must be prepared to demonstrate to the lending institution that the proposed financing is feasible.

In any borrower/lender relationship, it is essential that the borrower supply up-to-date financial and production records to provide an understanding of the business. Production records include livestock records such as Dairy Herd Improvement Association (DHIA) for dairy, production and weaning efficiency for livestock, and yields and costs for crop production. Financial statements include a balance sheet and an income statement, as well as historical and projected cash-flows. If possible, 3 to 5 years of financial and production data are desirable. Many lenders today are asking for income tax returns for 3 years. (See Part III for chapters on farm recordkeeping and accounting.)

On the other hand, it is the lender's responsibility to analyze these documents in a logical and systematic manner. This will result in a timely decision on the borrower's credit worthiness. While good financial management is the primary responsibility of the borrower, both lender and borrower must use sound credit practices.

Selecting a Lender

Selecting a lender or lenders is a critical aspect of financial management. A farm operator should shop for credit and investigate several sources before making a final decision. As a borrower, you must be prepared to make judgments, as well as to be judged. Here are five guidelines to use in rating the quality of the credit service.

1. Select a knowledgeable lender who understands agriculture today. Agriculture, undergoing rapid technological change, is beset with unique problems and opportunities. The lender must be able to demonstrate up-to-date knowledge of problems, trends, and modem agricultural practices specific to the particular enterprise and geographic region. Choose a lender whose track record shows an understanding of its farm customers and a genuine interest in and concern for the customer's welfare and financial progress.

2. Select a lender who has experience in agricultural credit and a commitment to agriculture. In recent years, a depressed agricultural economy has caused some lending institutions to exit agriculture. As a borrower, examine the lender's farm loan experience. Check its reputation by asking other farmers. Assess the lending institution's commitment to agriculture and service by looking at its track record during periods of adversity. Is the lender experienced in dealing with the programs you are involved with or interested in, for example Agricultural Stabilization and Conservation Service (ASCS) and Farmers Home Administration (FmHA) programs?

Become acquainted with a person in authority in the institution, and maintain a direct link with one or more people there for information and advice. By doing so, you can monitor the institution's financial stability and general attitude toward agriculture. Remember, senior management strategy influences an institution's lending policies.

3. Choose a lender who is willing to discuss lending policies and terms and provide prompt action to credit requests. While investigating a source of credit and related services, compare the terms of credit with other available sources. Remember, total credit charges are more important than interest rates alone. Credit expenses, such as up-front charges for farm loan application and closing fees, can add substantially to credit cost. Examine fixed- or variable-rate interest options and determine the associated costs, benefits, and risks.

Arrange repayment terms flexible enough to prevent undue hardship in case of special needs or emergencies. Payment schedules should mesh with the anticipated cash-flow generated by your farm business. For example, a dairy farmer may want monthly or quarterly payments, but a cow-calf or grain producer may prefer only one payment per year after the sale of the calves or grain. Investigate the privilege of prepaying without penalty.

Timely action on loan requests should be a high priority in selecting a lender. A delayed credit decision can hinder crop and livestock production schedules, and ultimately affect cash-flow and profits. Keep in mind, however, that the lender must have adequate information to make a sound credit decision.

4. Choose a lender who has the capacity to meet anticipated credit needs. Agricultural businesses frequently need large sums of capital. This could create a roadblock in the credit process. Some institutions may have a statutory limit placed on the amount of credit they can extend to any one individual or business.

5. Select a lender who has a reputation for honesty and integrity. In our market-based economy customer service is essential in doing business. Therefore, seek a lender familiar with and skilled in financial and production analysis. Periodic visits by the lender to your farm or ranch show sincerity and concern, and enhance the lender's understanding of your business. Have the lender explain all services offered in practical and understandable terms.

A lender with a reputation for honesty will judge potential borrowers on the same basis. A strong borrower/lender relationship is one of mutual confidence. Maintaining confidentiality of information and objectively evaluating a situation (in other words, being able to say "yes" or "no" to a credit request and backing the decision with facts) are strong attributes to consider in selecting a lender.

Preparing for the Lender

After selecting a lender, prepare for the credit request by following these five tips in negotiating a financial package with your lender.

1. As a borrower you must provide current, accurate financial statements and supporting records.

A current balance sheet with supporting schedules and inventories is essential. A record of earnings (usually an income statement) and a projected cash-flow for your business are also needed. A 3- to 5-year projected cash-flow period may be required, especially if you are anticipating a major change in your business. A good set of farm records showing production plans, short- and long-range goals, and procedures for implementation and evaluation will enhance your chances of selling your credit to a lender. In approaching a new lender, be prepared with all of these schedules, but find out specifically what financial information that particular banker wants.

Most lenders are accustomed to balance sheets and income statements prepared or compiled by a certified public accountant when dealing with commercial and industrial borrowers. An increasing number of farms and ranches are using professional services for their farm records. A common and significant difference between records prepared by an accountant and records prepared by an individual is valuation of assets on the balance sheet. Accountant-prepared balance sheets commonly value assets at cost less depreciation, while individuals commonly use cost or an estimate of market value. The issue of asset value is important because asset value variations also show up on the right hand side of the balance sheet as changes in net worth and they also affect leverage ratios such as percentage equity or debt/worth. If you do not use accountant-prepared statements, most lenders will desire a conservative estimate of asset values.

There are a number of excellent farm record systems available, many of which run on a microcomputer. Some will coordinate and reconcile income statements to balance sheets, ensuring consistent valuation resulting in a better tracking of earned financial progress.

2. Arrange credit in advance. Lenders do not like surprises. Thus, do not inform your lender of a major decision after the fact. This can destroy trust and credibility and make future credit more difficult or impossible to obtain.

3. Allow your lender time to review your plans and make suggestions. Major purchase decisions are sometimes made on the basis of emotion rather than profitability. A lender can provide objectivity and counsel in reviewing your credit request. Remember, explaining your goals and plans builds confidence and trust, which strengthens your working relationship.

4. Keep your lender informed. Even the best of businesses face adversity that reduces the ability to repay. Inform your lender as soon as possible of changes in plans or unforeseen problems that will interfere with making loan payments. Remember, communication is the key element in the initial request and throughout the credit process.

5. Maintain a high level of integrity. If you expect a lender to be honest and aboveboard at all times, then the same will be expected of you. Inaccurate information and failure to honor commitments will jeopardize the borrower-lender relationship.

Managing Credit Use

Once credit is obtained, properly managing the credit becomes a major challenge in your business. Three basic financial statements the balance sheet, income statement, and cash-flow statement are tools used to monitor the financial strength of your business. When compiled and supported by accurate financial information, these tools can provide the support needed for many of the strategies and financial decisions you face.

Any business whether it is an agribusiness firm, farm, corporation, or small business must meet certain criteria if it is to be successful, particularly if credit is used. A successful business must exhibit strength in repayment ability and capacity, liquidity and solvency, and profitability and financial efficiency. Coincidentally, the lender's cornerstones of sound credit, the five C's, encompass the same qualities:

1. Character (honesty, integrity, and management ability);

2. Capacity (repayment ability and profitability);

3. Capital (liquidity and solvency);

4. Collateral (minimizing risk to the lender), and;

5. Conditions (for granting and repaying the loan).

Both farmer and lender can assess the financial status of the business with these criteria.

Any analysis of the use of credit is only as strong as the quality of financial and other information provided. Circumstances such as size and mix of enterprises, costs, values, commodity prices, collateral values, type of business entity, and time of year can all affect interpretation. Also, be cautious; do not base final interpretation on any one factor but rather on a balanced comprehensive approach. In short, comprehensiveness is the number one factor in developing any valid analytical process.