The excess moisture in many parts of the Prairies this year could hurt the farm income of many producers.
It’s easy to forget during tough times that there are options to help mitigate the impact of adverse weather or fluctuations in the marketplace. And although you can’t control the weather or interest rates, you can control how you manage your operation.
A good first step is to visit your lenders. Maintaining regular communication with lenders when facing a potential financial crisis is critical.
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Producers have several options when experiencing inadequate cash flow. They may want to consider selling assets, contributing personal money to the business or asking someone other than a lender to invest in their farm.
Restructuring is another consideration.
Commonly known as terming out debt, it involves reorganizing a business’s debt.
In its simplest form, restructuring means moving some or all of the current debt, which is the amount due to be repaid in the next 12 months, to long term and changing the repayment schedule.
It doesn’t increase debt but does increase a long-term commitment to making principal and interest payments. The benefit is that the money received from selling inventory can now go to operations rather than paying off current debt obligations.
Also, if the original operating loan limit was left intact, that borrowing capacity is available to finance operations.
Shifting current debt to long-term debt might solve some problems, but it has its own issues. The farm has to have the historic, proven ability to be able to make the additional principal and interest payment. A lender might not approve the restructuring if the farm’s repayment history is weak. Then the farm might have to look for a new lending institution.
Lenders that perceive more risk usually demand additional security in the form of equity in assets. Unencumbered assets are the best source of additional equity, but remember to carefully consider whether to mortgage clear title land.
Arranging any amount of restructuring will be an accomplishment for some farmers. For others with lots of equity, the issue is how much debt to term out.
Producers need to determine how much working capital is needed to finance operations until the 2011 crop is ready for sale. Examining past cash flow is a good way to do this.
They will want to arrange the restructuring accordingly, terming out enough of the current debt to end up with the desired working capital.
The amount of long-term debt a producer takes will also have to be measured against the farm’s ability to make the additional principal and interest payment.
First, determine average net earnings, before depreciation and term interest, for the past three to five years. Divide this number by the annual principal and interest commitments before the restructuring. This is the debt servicing ratio.
Then take the same net earnings but divide it by the annual principal and interest commitment, including the new restructuring commitments. This is the revised debt servicing ratio.
Compare the two. Try to keep the new ratio to 1.5 or better, which is $1.50 of net earnings for every $1 of principal and interest. If restructuring causes the debt servicing ratio to fall to 1.25 or lower, it could cause problems over the life of a loan.
Restructuring debt is a common practice and may be a good option. Farmers should consider each option carefully and seek professional advice from lenders and independent farm management advisers.
Terry Betker is a farm management consultant based in Winnipeg. He can be reached at 204-782-8200 or terry. betker@backswath.com.
