When planning an expansion, farmers tend to focus on the construction and design parts of the building process. Although an important part of the process, farmers must have the plan approved by their financing institution. The expansion must make sense for the farm in terms of growth and profitability and also make sense to the lender. In a Penn State University Extension article, former educator Tim Beck identified five key areas that your ag lender will dial in on to determine if the expansion is a good move.

Current ratio: Found on the balance sheet, this ratio measures liquidity and provides the lender with an idea of whether bills and loan payments will be made on time. A higher ratio is desired, as it provides more flexibility in times of financial downturn. “A ratio of 2.0 would mean that a farm has $2 to cover every $1 of current debt. Banks would like to see this ratio over 2.0 to indicate a strong financial position,” Heck noted.

Debt to asset ratio: Compares total farm debt to total farm assets. Included in the solvency bracket, the higher the ratio, the more risk the farm has. Because of this, the lower the ratio, the better.

Term debt coverage: Measures the repayment capacity of the farm. “In order to stay out of the danger zone, term debt coverage should be greater than 1.25, but needs to reach levels of 1.75 or more to be in the green zone,” he said. The higher the ratio, the better.

Net farm income: While difficult to determine, this number measures profitability by determining the value of goods produced, compared to the cost to produce those goods.

Rate of return on farm assets: The average interest rate that all the investments on the farm earns. A rate of return on farm assets greater than 8% is considered strong, and the larger the percentage, the better.

At the end of the day, the ratio looks different for every farm. If the expansion makes sense and will allow your operation to continue to see steady growth, get in touch with your lender to provide more insight.