Your financial health
By Dr. David Kohl
Want to know whether you are in good financial health? Dr. David Kohl, a noted agriculture economist and advisor to RBC Royal Bank®, has worked with producers and lenders for over 25 years. He’s got four signs that indicate your financial health might need a checkup.
Technology, price, cost, and structural changes in agriculture place today’s agricultural economy on the edge. In my travels, I’m encountering two groups of customers in terms of profitability. One group is thriving, progressing, and expanding, while the other segment is hanging on for bottom line survival. In 25 years of working with agricultural lenders, I have observed the following signs indicating when a producer is in trouble.
SPLIT LINES OF CREDIT
During the farm crisis of the 1980s, I often served as a third party facilitator in problem loan resolutions. A common theme in most problem loan balance sheets was more than five different sources of credit or institutions financing a customer. This is an important symptom in today’s environment with more non-traditional lenders and competitors aggressively seeking market share.
Many producers in the later stages of financial difficulty will use one source of credit to make payments to another creditor. Overuse of easy financing terms such as no down payment or deferred payments options is a recipe for disaster. Split lines of credit present problems by complicating collateral and payment plans. Anyone attempting a workout or liquidation with numerous creditors realizes the difficulties in developing a win-win situation for the entire group. Consolidate as much debt as possible with one or two suppliers. Put together a debt servicing plan and stick to it.
STEER CLEAR OF THE BERMUDA TRIANGLE
Farms generating average gross farm revenues between $100,000 and $250,000 will face financial stress over the next five to seven years. These so-called “tweener farms” are in an agricultural Bermuda Triangle. Either they are too big to be small and too small to be big. There are approximately 75,000 of these farms in Canada and 500,000 in the United States, and of these farms, 40% will do quite well, 30% will struggle, and the other 30% will go out of business. Characteristics of the strugglers include less than $150,000 in annual sales, a debt-to-asset ratio greater than 50%, over 50 years of age, family living expenses above $30,000 annually and little or no non-farm revenue. This is the time to make hard decisions. Assess your goals and plans. Look for other possible areas where additional revenue could be generated. Talk to a farm business advisor.
THE TRIPLE WITCH
I like to perform a quick analysis of farm business stress by dividing farm interest expense into total farm revenues. With today’s low to moderate interest rates, this ratio should not exceed 15%, with less than 10% being ideal. Consistent ratios above 15% for three or more years limit the strategies available in a problem loan workout. If interest expense is greater than 20% of revenues, the debt-to-asset ratio exceeds 50%, and the operating expense / revenue ratio (excluding interest and depreciation) exceeds 80%, you have the triple witch with virtually no alternatives.
ACCOUNTS PAYABLE
Recently, I had dinner with a veterinarian and agri-businessman who sells feed and fertilizer. Both indicated that producers who are experiencing cash flow and earnings problems are delaying payments or making only the minimum required payment. This was the number one sign of financial problems in the 1980s. These signs are not all inclusive but they do provide you with a quick method of examining your financial health. Whether you are a primary producer or in the ag service industry, work closely with your customers.
So what’s the next step in maintaining and building a healthy business? I’ve found that behind every successful producer is a team of advisors that includes at least one of the following: an accountant, lawyer, farm business management specialist, financial advisor and farm finance specialist. Each one can help with a specific area of your business and their combined expertise will give you much more insight than you have on your own.
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