Financing the Agribusiness

1. Financing the Agribusiness Chapter 7

2. Objectives: • Discuss the importance of farm credit. • Explain three fundamentals of credit. • List eight rational credit principles needed for effective decision making. • Describe three areas for which credit is needed. • Differentiate the three lengths of financing terms. • Discuss the three types of loans. • Explain the components of a credit profile. • Compute interest. • List the agricultural credit sources for real estate and non-real estate loans.

3. It Takes $ To Make $ • Credit decisions are most important judgment by business owners • Determine if businesses will make a profit • Sufficient financial resources must be available • Money is used in every area of agriculture industry

4. Importance of Farm Credit~ • Credit is needed to overcome a shortage of equity capital • Restricted capital, changing interest rates, and lack of credit information are major problems • Credit allows farmers to: • Increase production • Improve the quality of what is produced • Revise operations to make them more profitable

5. Change in Credit Needs • Substitution of capital for labor • In 1900… • capital contributed 25% to the production process • labor contributed 75% • Today… • capital contributes 90% • Labor contributes 10%

6. Magnitude of Agricultural Credit • Ag products and services make up ¼ of the GDP in the US • In 2005… • Farm assets totaled $1.8 trillion • Real estate totaled $1.52 trillion • Non real estate totaled $210 billion • Financial assets totaled $67 billion • Total farm debt totaled $215 billion • Figure 7-2

7. 3 Fundamentals of Credit: • Returns • Borrow money to increase net returns • Will profit be greater by borrowing money? • Repayments • Principal plus interest • Farms usually posed as collateral • Foreclosure results from failure to repay • Risks • Strong assets = less risk • Weak assets = high risk • Lenders favor those who can absorb potential loss

8. Rational Credit Principles • Agribusiness profitability based on several components • effective use of farm credit • right combination of land, labor, equity, management, and credit • Page 145, Principles for Success

9. Credit Needs~ • Financing is needed in three areas: • Fixed expenses • items that can be used over a long period of time and incur the same expenses each year • Land, buildings, machinery and equipment, etc. • Operating expenses • Everything needed to run a farm or agribusiness • Transportation, utilities and fuel, etc. • Startup expenses • payable before the business begins operation • attorney’s fees, incorporation expenses, development costs, etc.

10. Length of Financing • Lending stimulates economic activity by providing purchasing options that would otherwise be impossible to obtain • Loan is a contract between the borrower and the lender • 3 borrowing time frames: • short-term • intermediate • long term

11. Short-Term Loans • Terms are one year or less • Main use is to finance operating inputs • Short-term operating loans are most common • Typical operating loan is for six months • Single payment retiring the loan amount at the end of the period • Suppliers of short-term loans: • Banks • Merchants • Individuals • Farm Credit Services

12. Intermediate-Term Loans • Vary in length from 1 to 10 years • Finance assets that may be depreciable • farm machinery and equipment • breeding livestock • irrigation systems • Suppliers of intermediate loans: • Commercial banks • Farm Credit Agency • May take collateral and liens on property to ensure repayment of loan

13. Long-Term Loans • Extend over 10 years • Used when buying: • Land • Buildings • Housing • Agribusiness start-up depends on these loans • Suppliers of long term loans: • Farm Credit Services • Commercial banks • Life insurance companies

14. Line of Credit~ • Allows the borrower to acquire funding up to a maximum amount • Used to buy production inputs such as fertilizer, feed, or feeder calves • Must be repaid completely within one year

15. Revolving Line of Credit~ • Allows producer to borrow up to specified limit • Loan amount fluctuates with seasonal credit requirements • No need to be completely paid off as long as adequate collateral is available • Generally more expensive than other loans • More flexible than other loans • Yearly renewals and increases are also available

16. Term Loan~ • Specified amount loaned for a specific amount of time • Paid off with a single payment or scheduled payments consisting of principle and interest • Detailed loan agreements generally accompany these loans

17. Components of a Credit Profile • Credit profile required with loan application • Want positive answers to the following questions: • Personal characteristics • Management ability • Financial position • Loan purposes • Loan security • Figure 7-6 for example of application

18. Computing Interest~ • Interest can be a major expense • Represent price charged for use of money • Supply & demand influence rates • Often fluctuate over time • Interest is “selling price” of loan to the buyer • Calculating interest is essential to controlling the cost of capital

19. Cost of Capital~ • Difference between amount paid for loan and amount received from it • For example… • Borrow $100 at 9% interest • 100*.09 = $9 • Cost of capital is $9 • APR (annual percentage rate) is a common name for the actuarial interest rate • 3 ways to calculate APR

20. Simple Interest • Applies to loans with a single payment • Example is a 6-month, short-term operating loan • APR is the rate charged if no down payment or borrowing fee is required • Previous example, APR was 9% • Page 153 • Remaining Balance Method • Add-on Method

21. Amortization Tables • Chart used to calculate the constant payments needed to repay principal and interest • Amortize - loan set up with equal installment payments • annual • semiannual • quarterly • Monthly • Figure 7-7, left column

22. Feasibility • Loan that generates enough after-tax income to pay for itself • Has a positive cash flow during loan period • Many ag investments show a negative cash flow during the first years of activity • Difference must be made up from profits in other parts of the operation

23. Profitability Index • Determining if benefits (income) outweigh costs (investment) • Benefits must be determined and divided by the costs • Useful management tool for making investment decisions • For example… • $110 benefit/$100 cost = 1.1 profitability index

24. Agricultural Credit Sources • Agricultural lending is big business • Major credit sources for agricultural industry: • Farm Credit System • commercial banks • Farm Service Agency (formerly FmHA) • Commodity Credit Corporation • life insurance companies • individuals

25. Non-Real Estate Loans • Money used to finance farm expansion and higher-cost production items • farm machinery • motor vehicles • In 1995, non-real estate loans totaled $72 billion • commercial banks supplied 50% • Farm Credit System supplied 17% • Farm Service Agency supplied 5% • Individuals supplied 21% • Figure 7-9

26. Real Estate Loans • In 1998, real estate loans totaled $87.6 billion • Farm Credit System supplied 32% • life insurance companies supplied 11% • commercial banks supplied 31% • Farm Service Agency supplied 5% • individuals supplied 24% • Farm Credit System is the largest lender involved in the land mortgage field