As one applies for agricultural credit, the lender expectations for documentation will vary with each request. Read on to find out how.
Source: GreenStone FCS Dollars and Sense Column in the Michigan Farm News
Requirements, Expectations for Future Financing
As one applies for agricultural credit, the lender expectations for documentation will vary with each request. If the loan will not materially change your farm operation, it's reasonable to expect a decision in a few days with minimal financial information. For example, at GreenStone Farm Credit Services, most requests for a $70,000 equipment loan require only the applicant's estimate of the market value of assets, total liabilities, annual gross income, and annual non-farm income.
Larger requests will require more information, but if the proposed transaction will not materially change the operation, a market-basis balance sheet with detailed schedules of assets and liabilities, along with three to five years of income and expense records, should suffice.
If an expansion is being planned and the present operation will not cash flow the requested financing, the required documentation changes dramatically. The applicant should complete a detailed balance sheet, then create a post-expansion balance sheet, being careful to anticipate all needed new assets and what those assets will realistically cost. Some expansion costs can easily be missed. New facilities often require a new well, a new driveway or other items that are easily overlooked. If the dairy herd will be expanded, the forage inventory will typically need to become larger, which takes working capital. Where will it come from? Many managers find, during the expansion process, that there are enhancements they cannot do without. Often these enhancements are well intentioned and may even generate strong returns on the investment. Perhaps a neighbor, seeing construction in progress, stops by to say what he would do differently if he could do his expansion over again. Such conversations are valuable. Visit other operations and engage in such conversations early during the planning process. Another expense that often is overlooked is interest expense that occurs prior to the beginning of increased cash flow. Money is not free during construction or during the years between planting the apple tree and the harvest, when sales exceed annual expenses.
Next, a post-expansion income and expenses projection needs to be created.
The first step in creating the projection is to identify reasonable production and price assumptions. Any variation from the actual experience during recent years should be explained in writing. Lenders look at the expense ratio. This ratio is determined by deducting depreciation and interest from total expenses, then dividing this adjusted expense number by gross farm income. Any material change (reduction) in the projected expense ratio from the historical average needs to be fully understood and explained. When it comes to projections, the devil is in the details. Be prepared by providing written descriptions of crop and livestock budgets. How much feed might you need to buy at what price? You may want to create several "what if" projections that show the impact of variations in production and price.
Often the question is asked, do I have to provide all this in writing and do I need to provide a written business plan? The short answer is usually no, but you can use both to your advantage. The business plan is especially important if you are undertaking a new enterprise. Hiring a consultant can be worthwhile, but the projection and plan need to be yours. You need to be able to explain and defend what you present to your lender.
If the loan application process goes as it should, regardless of the decision, the farmer and the lender should leave better informed and more knowledgeable.