The Rural Voice, 1982-07, Page 29Financial and marketing management,
plus production - - the key to success
By W.H. Bearss
Royal Bank of Canada
Presented to the Ontario Pork Congress
The difficult economic times experi-
enced by Canadian farmers over the past
two years have prompted considerable
interest in the financial management
aspect of farming. Historically, the
emphasis in farming has been almost
exclusively restricted to the application of
new developments in production technol-
ogy, in areas such as breeding, feeding,
crop production and mechanization. To a
large degree farm financial and marketing
management have not kept pace with the
advances in production management.
Consequently many farmers are entering
the 1980's equipped with a 1950's
knowledge and understanding of these
two critical areas of overall farm manage-
ment.
In the time available it is not possible to
provide a 30 year education on the
complex problem of financial manage-
ment. However, I will attempt to introduce
a number of factors that a banker, and for
that matter most financial analysts, take
into consideration when reviewing an
account. Hopefully, 1 will sow the seeds of
curiosity and interest on your part. which
will prompt you to pursue this subject
further with a view to improving the level
of financial management being exerted in
your farming operation.
The question has been posed: "How
do you decide whether to finance a
proposal in Agriculture?" In other words,
what makes a proposition "bankable"?
It is important to recognize, at the
outset, that the credit decision in Agricul-
ture is essentially the same as the credit
decision in any other business enterprise.
That decision making process is often
referred to as the "Three C's of
Credit: -Character, Capacity and Col-
lateral".
Character, refers not only to the
personal integrity and trustworthiness of
the client, but also takes into considera-
tion management skills, dedication to the
business, track record of debt repayment,
and approach to future planning for the
business. Character is the single most
important factor in the credit decision for
both the banker and the client. It allows
both parties to identify whether they wish
to deal with one another.
In the case of young inexperienced
farmers, consideration of character be-
comes a dominant factor because usually
there is a significant absence of collateral
and capacity which must be offset by hard
work, determination and ambition, and of
course overall management skill. The
quality and depth of management is
critical to the future success of a farming
operation. That management skill must
include production. finance and market-
ing.
Capacity is the ability of an operation to
meet its debt obligations as scneduied, or
in other words "How will loan, principal
and interest be repaid?" Hard work,
ambition and good management are
critical components in the generation of
funds to service debt, but identifying
those revenues that will be available after
the production costs and grocery bills are
met, often is related to one's ability to
predict the future. In this regard the cash
flow projection is the most frequently used
tool.
A track record of consistently meeting
budget projections, or at least maintaining
control of the income and expense areas
that are controllable by the farmer. is of
significant comfort to the lender. Projec-
tions that indicate dramatic but hardly
realistic improvements in debt servicing
capacity from one year to the next without
adequate substantiation, are likely to raise
suspicion.
In the event that problems develop in
the ability of a farm business to meet its
debt obligations, the lender has a
secondary source of repayment through
the sale of collateral security. The extent
to which collateral security is requested
usually is dictated by the degree of risk
associated with the management ability
(character) being exerted to achieve the
necessary debt servicing capacity. Ob-
viously, when the risk of repayment from
earnings is high then the lender relies
more heavily on the security to protect
the loans. However, a loan that offers
collateral security, but does not represent
a strong business proposition will not be a
bankable deal. Normally, the life of the
security matches the life of the loan. It
doesn't make sense to lend money over
ten years on a tractor purchase when the
tractor might be long gone after five years,
and no security left to support the balance
of the loan outstanding.
The previous discussion of appraisal of
the suitability of financing places con-
siderably more emphasis on the import-
ance of debt servicing than security when
making a loan. Over the past decade,
there has been a distinct shift in lending
philosophy away from the traditional
assessment of net worth or equity, as the
basis for approving a loan. In the past, a
lender relied on the surplus value of assets
over liabilities to cover the required
repayment of the loan, without much
attention being given to the primary
source of repayment. Inflated asset
valuations, high interest rates and thin
profit margins have corrected that ap-
proach. The lender doesn't want to own
your asset, he wants you to pay the money
back and have you keep your asset. This
does not mean that an analysis of the
balance sheet is not important in the
lending decision. The information con-
tained in the balance sheet, such as net
worth, working capital, debt distribution
relative to asset holdings and comparison
against previous years' figures is very
useful in assessing the financial stability
of a farm business. A series of balance
sheets from previous years. accompanied
by income and expense statements, is like
a photo album that documents where the
business stands today and to a large
degree, how it arrived there. The cash
flow, on the other hand, attempts to
predict where your business is going from
here and how it will get there. The track
record of performance allows the lender
and the farmer to assess the probability
and accuracy of projections of the future
potential to service debt.
William H. Bearrs, P.Ag., is Regional
Agricultural Services Manager for The
Royal Bank of Canada. The second half of
his lecture at the Ontario Pork Congress
will be reprinted in the August issue of
The Rural Voice.
THE RURAL VOICE/JULY 1982 PG. 29