In a recent webcast with agricultural lenders, a participant posed an interesting question, “How should a lender proceed with a borrower that has negative cash flow and declining equity from three to five years of bad crop seasons?” This question is being asked across the country as market volatility and extreme weather, such as too much rain, extended drought, heat, and wildfires, have eroded business equity and emotionally drained producers.
The first step is to uncover the real reason for the losses. Were the losses a result of weather or below average soils prone to weather abnormalities? If weather was the issue, what was the risk management program level of coverage and were the programs properly executed?
Next, were the losses a result of a combination of weather and flaws in the marketing and management program? Were there any profit windows or opportunities to minimize losses that were not executed? One would ask the producer what was their cost of production and breakeven points for the various commodities raised on the farm.
The next step would be to objectively determine how mounting losses are depleting equity and working capital. This can be done simply by dividing the annual loss after operating expenses, debt service, taxes, and living expenses into working capital or equity reserves. For example, if the equity is $1 million and the losses are $200,000 per year, the excess equity would disappear within five years. Equity is often the retirement program for many producers. Continued diminishing equity can put the individual in dire straits in their golden years. Another analysis to conduct would be to divide the losses into excess equity after a 10 to 30 percent decline in the net worth due to market conditions. In this example, a 20 percent decline in net worth due to changes in market values would result in a burn rate of four years.
Finally, what is the plan for improvement? This year government programs such as the Paycheck Protection Program (PPP) provided an economic bridge for many producers. Can adjustments be made in production, marketing, and risk management plans moving forward? How will these plans be monitored for progress? Producers must be proactive in developing these written plans because a plan developed solely by the lender can have legal implications.
Bad luck can occur; however, one must objectively think through the unintended consequences so that the long run financial conditions are not hindered beyond repair.
Source: Dr. David Kohl, which is solely responsible for the information provided and is wholly owned by the source. Informa Business Media and all its subsidiaries are not responsible for any of the content contained in this information asset.