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Are You Ready for More Dairy Lender Scrutiny?
May 21, 2015

This past Thursday, May 14, the Federal Reserve Bank of Kansas City released a survey of bankers that showed deteriorating cash flow on Midwest and Mid-South farms. 

While the situation is not yet dire, it is raising concern: “The stress of lower farm incomes is beginning to adversely affect working capital, therefore boosting loan demand while curtailing the rate at which farmers repay their loans,” says the Fed in a press release it issued Thursday.

Adds one Missouri banker: “Most producers are not able to lower operating expenses significantly and are looking at troublesome cash-flow projections.”

David Kohl, an agricultural economist with Virginia Tech, predicted as much two months ago at the Professional Dairy Producers of Wisconsin annual business conference in Madison.

As farm financial margins tighten, lenders are coming under increasing pressures from bank regulators to ensure their accounts—and yours—are in order, he says. “Lenders will be under tremendous scrutiny from regulators this year,” says Kohl.

So it’s critically important dairy borrowers demonstrate that their financial statements are in order. Lenders will want to see:

• A history of profitability.

• Evidence of building working capital.

• Strong loan coverage ratios.

• A willingness to develop corrections to financial plans when warranted.

• Moderate family living costs.

“Family living cost is the big one,” says Kohl. “The biggest competition for cash flow is family living.” In good times, family living costs can balloon to $125,000 to $175,000. But even “low” family expenses can take $40,000 to $70,000 annually.

Your farm’s financial resiliency can be calculated by your “burn rate”—how quickly your working capital is depleted. You’d like to have a burn rate of 3 ½ years or more.

“Determining your burn rate gives you some boundaries as to when you have to make some tough decisions,” says Kohl. “Murphy’s Law is merciless when you don’t have working capital.”

Calculate your burn rate by first subtracting current liabilities from current assets to determine net working capital. For example, if you have current assets of $1,000,000 and current liabilities of $500,000, your net working capital is $500,000.

If you have a net income loss of $200,000, your burn rate is 2.5 years ($500,000/$200,000).

If you are still (hopefully) operating at a profit, divide your working capital by annual debt service payments (interest and principal) to calculate your burn rate. Example: If you have working capital of $500,000 and interest and principal payments of $100,000, your burn rate is five years.

If your burn rate is five years or greater, you’re in the green light zone and your operation is operating safely.

If the burn rate is between 2.5 and 5 years, you have entered the yellow, cautious zone.

And if the burn rate is less than 2.5 years, you’re in the red light zone.

As you approach 2.5 years of burn rate, you’ll have to make some progressively harder choices:

• Can you moderate family living?

• Can you control costs?

• Do you have an effective risk management plan in place, and have you followed it?

• Can you shed marginal land, machinery or human assets?

By: Jim Dickrell, Dairy Today Editor
Souce: Dairy Today, AgWeb.com

 


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