Tractor in field

Farm finance experts say the right approach and strategies can help farmers succeed, especially as they're getting their farming operation started. 

Getting started in production agriculture is expensive. If new operators don’t have access to land and assets, they likely require a good lending partner.

Developing a business plan and a relationship helps build trust between the parties, while lenders project realistic markets and cash flow to understand the operation’s risk.

“For a startup, there’s no historical earnings data. That forces an owner or lender to make a lot of assumptions when they’re projecting future income and expenses,” said Jay Sloniker, FCS Financial vice president for commercial and ag business.

Start with a plan

For new operations, it’s best to do some homework and stay conservative. Producers also need to budget expenses to determine cash flow.

“I see new producers or producers that are expanding do a good job accounting for large ticket input expenses like feed, fertilizer, grass seed, etc. Those are things that are pretty easily identified,” Sloniker said.

Meanwhile, expenses such as insurance, property taxes and utility bills may not be associated with production, but they impact the budget.

Other expense categories to include are depreciation, breeding and marketing. “[Depreciation] isn’t something you write a check for, so it’s easy to leave out of the budget,” Sloniker said. But equipment and livestock need replacing over time. That expense needs to be addressed over the long run. If you don’t plan for it, you can end up in a big problem because you have to have those items to operate.”

With a plan in place, it’s time to visit the banker.

“The one thing that a new producer should be able to do is articulate their plan clearly to a lender,” Sloniker said.

Explaining the farm’s budget, operating and marketing plan helps the lender understand the producer’s capability.

“If I have a borrower that can communicate his plan clearly and show he’s thought through everything, that goes a long way in offsetting risk associated with a startup,” he said.

Five C’s

After Sloniker has the business plan, he makes his decision based on five criteria: capital, capacity, collateral, character and conditions. The Farm Financial Standards Council provides benchmarks to help lenders evaluate risk potential.

Capital measures an operation’s net worth.

“We like to see 20 percent net income or more,” Sloniker said. “If you’re selling $100,000 of calves each year, the target would be $20,000 working capital or cash equivalent,” he said.

Loan applicants should be majority shareholders in the operation too.

“Forty percent or below in regards to owner’s equity is an alarming level for us,” he said.

Capacity evaluates cash flow.

“We use a lot of different ratios, but the key is to have 115 percent capacity,” Sloniker said. That allows producers to pay their bills, pay themselves and still have money to operate.

Collateral and character are pretty self-explanatory. Sloniker likes a 30 percent down payment on real estate and 25 percent for machinery and livestock.

For character, Sloniker considers credit and payment history. He wants applicants to have a credit score above 660.

“There’s a hundred different measures under the character umbrella,” he said. “Conditions come into play the larger the lending relationship gets. If applicants are interested in a large loan or a line of credit, there may be stipulations.”

Sloniker may require a co-signor or an annual audit of the balance sheet.

Track progress

Once producers are operating, it’s important to avoid overextension.

“The first step is to be able to monitor that balance sheet on a regular basis,” Sloniker said.

He recommends producers do this the same time every year.

“I equate it to the dashboard on my car. If you don’t know how much gas you have, the engine temperature, etc., that’s going to make it difficult to get from point A to B,” he said. “That’s what a balance sheet is — a snapshot of what’s happening right now.”

Next is updating the budget. Sloniker suggests doing this monthly. This helps producers track progress and make adjustments as needed before they get in a bind.

“If I sit down every six months, it may not be as frequent, but it takes more time. It’s easier to stay on top of it on a monthly basis,” he said.

Managing the budget includes monitoring expenses. This is the biggest mistake Sloniker said he sees new producers make. When success comes, it’s tempting to increase spending.

“The equipment line is where I see a lot of people get carried away. It’s very easy to overspend on equipment because credit availability is good,” he said. “That’s the one item or group of assets that producers need to take a hard look at — whether it’s a want or a need.”

The next mistake is buying non-income producing assets. New trucks and big houses are only a wise purchase if producers have the cash on hand.

“You should make sure you have the availability of cash flow or earning to take care of it because it won’t pay for itself,” he said.

Finally, producers should maximize efficiency before spurring growth.

“Dr. David Cole from Virginia says ‘Better is better before bigger is better,’” Sloniker said. “Make sure you’re as good as you can be on the current scale. If you’re not making more on every acre or head, expansion will not make you profitable.”