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What happens when repayment fails?

Throughout the country many lenders and producers dealing with the grain industry may face situations when repayment is not possible this winter and into 2015. With high cash rents and leases, along with input cost creep, there is a strong possibility that 2014 and 2015 may not cash flow and may show negative repayment capacity for many grain producers. Now what? This is a question being asked by many.

In the last column, I discussed decision making tools that could increase the bottom line margin and repayment capacity. Now, what is the next step in financial analysis if there is a negative margin? When one does not generate sufficient cash flow to meet obligations, the fallback position is financial liquidity, specifically, working capital. In the last column we discussed an example illustrating repayment capacity. In both cases, the coverage ratio was at least 100%, ranging from a margin of $200,000 to zero.

ag loan repaymentNow, assume conditions have worsened. The prices of corn, soybeans and wheat have declined, reducing the projected 2015 revenue to $600,000, resulting in a coverage ratio of zero and a $100,000 negative margin, which is not good. We must analyze our fallback position called working capital.

Fortunately the producer was wise enough to stash some of the previous year’s profits in the form of working capital. In this case, current assets are $400,000 including inventory, receivables, crops growing in the field, and prepaid expenses. Current liabilities are $200,000 including operating line of credit, payables, and principal due on loan commitments within the next year. This results in $200,000 of working capital, or a 33% working capital to revenue ratio ($200,000 divided by $600,000 of revenue).

Now to meet bills and debt service requirements, the producer could divide the working capital of $200,000 by the projected margin losses of $100,000, which would equal a two-year working capital burn rate. The key would be whether the producer can sell liquid assets on a timely basis to generate cash for obligations. Having this working capital would provide the producer time to make adjustments in marketing tactics, risk management strategies, and business expenses such as cash rents, as well as living costs.

What would happen if a producer did not have the discipline to build working capital? Then, a total refinance of debt may be necessary requiring additional collateral pledged as security. In an environment where possible land value corrections may take place, lenders have less of an appetite for this strategy than in previous years when land values were appreciating at a double-digit rate annually.

Repayment ability and working capital will be hot topics in the grain industry this winter and in 2015 as producers and ag lenders work side-by-side to weather the economic punch.

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