This article was originally published in Progressive Dairy
Dairy farmers have experienced strong prices this last year, though rising input costs may have tightened cash flows. Hopefully, dairy operations are entering this new year with a strong working capital position and have adequate liquid assets available in the short term.
Regardless of whether the operation has adequate funds or not, you need to have a strong relationship with your lender. Successful farmers know building a relationship with their lender is a wise business strategy. The lender may be in a unique position to assist the dairy farm in planning for the future, while navigating current dairy markets, opportunities and obstacles that may arise.
Lender’s perspective
Getting to know your lender through open dialogue and good communication is key for both parties. Understanding the lender’s perspective may give you some insight into what they might be looking for from you when you approach them with a new loan request or loan renewal.
A lender’s primary interest is in whether your dairy farm operation is likely to fulfill the requirements of a credit agreement. When a creditor lends you money, he or she does it with the expectation of earning a profit, which is unlikely to happen if there’s a good possibility you’ll default on the loan. The lender will be more willing to act favorably on your future loan requests if you can be viewed as someone who will make a full and timely repayment.
Loan evaluation
Because they’re human as well as individuals, lenders vary in their ways of evaluating loan applications. A single lender may use different methods to evaluate different applicants. Some lenders may emphasize personal qualities that were impressive from a face-to-face interview along with opinions from references. Others will strictly follow a list of established guidelines related to income, length of employment, past payments and current debts, and the like. However, most lenders take a more intermediate approach, evaluating a loan applicant based on both subjective and objective criteria.
Six C’s of credit
Lenders may analyze the creditworthiness of a borrower by using the six C’s of credit. Each of these criteria helps the lender to determine the overall risk of the loan application. While each of the C’s is evaluated, none of them on their own will prevent or ensure access to financing. There is no automatic formula or guaranteed percentages that are used. The six C’s are only a variety of factors lenders evaluate to determine how much of a risk the potential borrower is for the financial institution.
- Character – This is a highly subjective evaluation of your history, including management skills in production, risk management and financial management. Other attributes could be considered, such as honesty, commitment, ambition, integrity, overall ability.
- Credit – History and experience are obtained from consumer credit reports or business reports. Credit can also include an analysis of financial statements, including the balance sheet, income statement, statement of cash flows, statement of owner equity, financial scorecard.
- Capacity – The ability to repay debt obligations and payment history, which includes the level of risk management, such as insurance, forward contracting or hedging, prepaid or early purchases and other income sources for repayment.
- Capital – Owner’s equity and personal investment in the dairy farm. Sources of equity include earned, inherited and inflation. Review equity trend over time.
- Conditions – View assets and property. Production reports, appraisal of machinery or real estate, and current status of the overall economy and dairy industry are considerations.
- Collateral – Assets used to secure loans, such as machinery, cattle, real estate. Personal guarantee or outside sources to guarantee loan repayment.
Information gathering
As you are building a relationship with your lender, there are several pieces of information you should gather and have available if you are pursuing a loan application.
Business plans can be written or only thought about and not yet put on paper. Plans should contain background/farm history, strategic plans, goals and objectives, reasons for decisions, timelines, budget projections and marketing plans.
Financial information should be current (within 90 days or fiscal year). You may need to provide a current balance sheet, property tax bills, income statement/tax return, production reports, personal debt (if not listed on farm balance sheet) and other sources of income.
Be prepared to answer these questions your lender may ask about your dairy farm operation:
- Dairy – Culling rate? Average milk price received? Cost of production?
- Crop – Typical rotation? Crop insurance?
- Beef – Days to market? Weight sold at?
- How are duties divided up among employees/owners?
- Do you have a succession plan?
- Who are the current consultants used?
- Who is your tax preparer/accountant? Insurance provider?
Loan application review
You have provided the lender with information for a loan application. As they review and process, keep in mind, the lender will be asking these questions.
- Is the decision right for the lender? What is the farmer’s current risk exposure? Will this impact any future loan requests?
- Is the decision right for the borrower? Will this loan application improve the farm operation now or in the future? Is the farmer able to handle additional risk?
Maintaining rapport
Congratulations! The lender has approved your loan application. Here are key steps to maintaining a good rapport and continuing to build your relationship with the lender.
- Arrange credit in advance – don’t inform your lender of a major decision “after the fact.”
- Allow time for lender to make decisions – the lender can be a source of sound advice and counsel when reviewing credit requests.
- Inform lender of any problems and changes – communication is important not only for this request but throughout the whole credit process.
- Maintain integrity – inaccurate information or failure to honor your commitments will jeopardize your relationship, as well as harm your credit ratings.
Summary
Agricultural financing can be a crucial tool to continuing production, expanding operations or trying different enterprises. Through a better understanding of agricultural lending, business planning and other ways of communicating with your lender, farmers will improve their chances for success. When the lender feels good about your relationship, they are more likely to manage and assist your operation through a tough situation now and in the future.
