Upgrading Your Financial GPS
Tuesday, May 1st, 2012
Our article series have covered three of the primary underwriting standards: debt coverage ratio, debt to asset ratio, and loan to value. In this last article in the series, we will discuss the current ratio/working capital and credit scores. We will also talk about the value of even‐dated, annual balance sheets and of establishing good historical records for your operation.
The current ratio is a measure of your operation’s short term liquidity and ability to meet its outstanding obligations over the next year from internal funds. The standard for this ratio is usually 1.25:1:00. The ratio is calculated from the balance sheet by dividing total current assets by total current liabilities. In this calculation, current liabilities should include accrued interest and the principal portion of intermediate and long‐term debt due within the next twelve months. A higher ratio indicates a better ability to withstand short‐term cash flow problems, whether from decreases in income or increases in expenses, without having to increase borrowing.
Working capital is determined by subtracting total current liabilities from total current assets, and indicates the amount of cash or its equivalent you have available for operating expenses, living expenses, capital purchases, etc.
Credit scores have become a more significant factor in recent years in evaluating loan applications. Currently, our standard loans that are not guaranteed by the Farm Service Agency require a credit score of at least 680 for each applicant. In addition, the credit report cannot show any recent delinquent payments on any real estate loans, either active or paid off. Therefore, it is in your interest to review your credit report at least annually and dispute any information that you believe is not correct.
In concluding these articles, we want to emphasize the importance of keeping good financial and production records on your operation. These records can start with an annual balance sheet (preferably dated 12/31), your tax return and an annual production history showing crop acres and yield, dairy cow numbers and average milk production, etc. You can then go into as much more detail as you find useful in managing your operation. Keep in mind that the goal is to develop an information base that helps you make sound management decisions.
An annual balance sheet dated December 31st that contains sufficient detail to accurately reflect current assets and liabilities (including accrued interest and the current portion of intermediate and long‐term debt), and total assets and liabilities, both farm and non‐farm, is essential. First, it provides you with one measure of the progress of your operation when it is compared to previous year‐end statements. It also allows lenders to make adjustments to tax return income if there have been net increases in crop inventories, etc that do not show up as cash sales. Finally, it enables you to calculate earned net worth. As we discussed in previous articles, increases in net worth can come from earnings and/or the appreciation of assets. It is useful to be able to determine how much of the increase is coming from earnings and how much from asset appreciation.
The goal of our Financial GPS series is to help decode your lender’s language. With over 80 years of ag lending experience, we understand agricultural real estate lending. If you are going to be making decisions about your operation based on the information you assemble, you want the information to be as complete and accurate as is reasonable. If you do not have access to a balance sheet or cash flow worksheet that meets your needs, please contact one of our experienced Loan Underwriters at 800‐876‐ 2362.
American Farm Mortgage Company (AFMC) is a nationwide ag real estate lender specializing in Full Time Farm Loans and Farm Service Agency Guaranteed Loans. AFMC’s strong relationships with secondary market investors enable us to offer an extensive range of products to fit most agricultural real estate financing needs. For more information, call us at (800) 876‐2362 or visit our website at www.americanfarmmortgage.com.