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It’s time to stress-test your farm business financials

What’s happening with your agricultural lender? Well, state and federal regulators continue to intensify the scrutiny of loans and the total agricultural portfolio. With commodity prices falling and more negative margins, lenders are now asked to “stress test” your financial conditions as well as their agricultural portfolio. Let’s examine what is involved in “stress testing” and what may be yet to come.

In regards to projected cash flows, producers must develop “stress testing” measures for income and expenses.  Separately, stress test your revenues up to 10 percent lower, and expenses up to 10 percent higher. In some cases, 5 percent may be sufficient if you can demonstrate the ability develop and execute a risk-management program, both on the revenue and expense side. The key is a past history of executing a risk-management program. This trend must be documented. Additionally, while stress testing, include rising interest rates on any variable rate credit, up to 1 percent.

Another area to stress test is working capital, which is current assets minus current liabilities. Then, divide this number into the total revenue or expenses. Closely monitor this percentage for rate of decline, particularly if you exhibit negative margins. Next, divide the negative margin into working capital to determine the burn rate. The resulting number represents how many years it will take to burn through your working capital, or financial shock absorber, as I call it. Burn rates of 2.5 or higher represent a stronger situation because there is enough time for corrective strategies to be implemented.  A rate under 1 indicates a sense of urgency with fewer options.

Next, be prepared for your lender to stress test your asset values. Expect 20-50 percent lower values on machinery and equipment, and 10-30 percent declines on livestock. Depending on your local conditions, land values will most likely be assessed 10 to 25 percent lower than current value to determine the strength and resiliency of your balance sheet equity.

Another shock test of the financials is the ability to document your assets, which includes serial numbers on machinery or identification tags on livestock. In addition, more oversight will be applied to your liabilities such as open accounts and credit cards along with written agreements and contracts with agribusiness firms or other individuals.

Producers with larger operations should also expect more scrutiny. Why? Well, portfolio concentration and third-party, interconnected risk could quickly lead to overexposure for your lender or institution. These types of risk will be watched closely.  Remember, in the 1980s debt was dispersed over the entire agricultural sector. Today, 63 percent of farm loans involve only 10-12 percent of producers.

The other side of the ag lender desk is a completely different world. The agricultural industry, as a whole, presents risk and possible overexposure for lenders and institutions that are not extremely careful. However, “stress testing” will not only help your situation with a lender, it will also better demonstrate the areas and levels of risk in your own business.  As a producer, you need to be prepared and proactive!

(Source – http://cornandsoybeandigest.com/blog/its-time-stress-test-your-farm-business-financials)

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