Leading financial advisors offer their advice to dairy producers as we wade through today's financial difficulties.
David Kohl is professor emeritus of agricultural finance and small business management at Virginia Tech, Blacksburg, Va. As owner of AgriVisions, he continues to advise businesses.
Gary Sipiorski is the dairy development manager for VitaPlus of Madison, Wis. He is a member of the board of directors with Citizens State Bank of Loyal, Wis.
How would you restructure debt?
Kohl: First of all, your lender will require a business plan with a full set of financial statements, including three years of accrual adjusted income statements and an up-to-date balance sheet. They also would like to see projections with sensitivity analysis on changes in milk prices, feed cost, interest rate, and so forth. Be prepared to give the lender a personal balance sheet and up-to-date credit scores. Develop your plan well ahead, and do not expect an answer yesterday.
Some additional questions include: Have you had a pattern of refinancing or is it occasional? Is the reason for refinancing because conditions are out of the manager's control, such as macroeconomic changes like milk price or a disaster? Or has your dairy been operating with continuous losses, reducing earned net worth on the balance sheet? If the latter, you may have difficulty refinancing.
Sipiorski: Begin by taking a hard look at the current balance sheet. Restructuring loans may be lengthening them out and/or borrowing more money against the present balances.
What is the loan-to-value of the real estate loans on the farm? How much will the lender borrow on the loan-to-value? Traditionally, lenders have borrowed up to 65 percent of the appraised value. An appraisal will need to be done. Real estate loans allow the lender to use up to a 20-year amortization. These loans will carry the lowest interest rate. The cash flow will be helped with low payments.
The next area to look at is the cattle and machinery. How much money will the lender allow to be borrowed against this personal property? Generally, lenders will go up to 70 percent loan of the value on this collateral. These amortizations are shorter at 3 to 7 years.
Farm Service Agency (FSA) guarantees should be considered. A mixture of real estate and personal property guarantees up to $1.1 million dollars with a 90 percent guarantee to the lender can be obtained. The personal property loans can have amortizations of up to 15 years with real estate loans of up to 40 years. FSA direct loans can also be applied for with up to $300,000 for cattle and machinery and another $300,000 for real estate. These loans will have the same type of an amortization as the guaranteed loans. Direct money from FSA will be at lower interest rates, as well.
The last and worst way to restructure loans is to have the lender write down the principal. This will be a last resort effort. Oddly enough, it is now being done in the housing market.
What is the correct liquidity ratio?
Kohl: I recommend using the working capital-to-revenue ratio. The old current ratio is becoming antiquated as operations become larger and more complex. Let's look at it with a stop-and-go-light analogy.
Green light: Greater than 33 percent - If the producer has high debt levels, is moving into a major expansion, or is coming off a profitable cycle in the industry along with a good risk management program for young producers.
Yellow light: 10 to 33 percent - If higher equity above 70 percent or coming off a down cycle in prices, such as recently.
Red light: Less than 10 percent - Either extremely high equity more than 85 percent, a great risk management program, or frugal living.
Working capital can take a number of years to build up only to be used up in 6 to 10 months like during the last down cycle. With higher volatility in milk prices and input costs, this metric will become more important.
Sipiorski: A dairy operation should have $2 of current assets for every $1 of current liability. That would be called a 2:1 ratio. This means there should be two times the amount of current assets of cash, feed, and other current assets which will be turned into cash in the next 12 months compared to the current liabilities of bills owned and principal due in the next 12 months. A 1.5:1 ratio is about as skinny as dairy should go. This may seem like a lot of liquidity. But this is a safe level; think about how this kind of liquidity would have felt in 2009.
Where does return on operating expense need to be on a good operation?
Kohl: I also like the operating expense to revenue ratio (excluding interest and depreciation or corporate management fees). As for benchmarks:
Green Light: less than 70 percent
Yellow Light: 70 to 85 percent
Red Light: more than 85 percent
Thus, top level producers will have 30 percent margin. However, examine this over the years and through the cycles.
Sipiorski: On most dairies, an 85 percent expense rate is as good as it is going to get with the current market conditions. If it is possible for a dairy to lower their expenses below 85 percent, they will be a winner over others. Today's economics does not seem to be allowing dairy producers to capture any more than a 15 percent return.
For more information read the July 2010 issue, page 469
David Kohl is professor emeritus of agricultural finance and small business management at Virginia Tech, Blacksburg, Va. As owner of AgriVisions, he continues to advise businesses.
Gary Sipiorski is the dairy development manager for VitaPlus of Madison, Wis. He is a member of the board of directors with Citizens State Bank of Loyal, Wis.
How would you restructure debt?
Kohl: First of all, your lender will require a business plan with a full set of financial statements, including three years of accrual adjusted income statements and an up-to-date balance sheet. They also would like to see projections with sensitivity analysis on changes in milk prices, feed cost, interest rate, and so forth. Be prepared to give the lender a personal balance sheet and up-to-date credit scores. Develop your plan well ahead, and do not expect an answer yesterday.
Some additional questions include: Have you had a pattern of refinancing or is it occasional? Is the reason for refinancing because conditions are out of the manager's control, such as macroeconomic changes like milk price or a disaster? Or has your dairy been operating with continuous losses, reducing earned net worth on the balance sheet? If the latter, you may have difficulty refinancing.
Sipiorski: Begin by taking a hard look at the current balance sheet. Restructuring loans may be lengthening them out and/or borrowing more money against the present balances.
What is the loan-to-value of the real estate loans on the farm? How much will the lender borrow on the loan-to-value? Traditionally, lenders have borrowed up to 65 percent of the appraised value. An appraisal will need to be done. Real estate loans allow the lender to use up to a 20-year amortization. These loans will carry the lowest interest rate. The cash flow will be helped with low payments.
The next area to look at is the cattle and machinery. How much money will the lender allow to be borrowed against this personal property? Generally, lenders will go up to 70 percent loan of the value on this collateral. These amortizations are shorter at 3 to 7 years.
Farm Service Agency (FSA) guarantees should be considered. A mixture of real estate and personal property guarantees up to $1.1 million dollars with a 90 percent guarantee to the lender can be obtained. The personal property loans can have amortizations of up to 15 years with real estate loans of up to 40 years. FSA direct loans can also be applied for with up to $300,000 for cattle and machinery and another $300,000 for real estate. These loans will have the same type of an amortization as the guaranteed loans. Direct money from FSA will be at lower interest rates, as well.
The last and worst way to restructure loans is to have the lender write down the principal. This will be a last resort effort. Oddly enough, it is now being done in the housing market.
What is the correct liquidity ratio?
Kohl: I recommend using the working capital-to-revenue ratio. The old current ratio is becoming antiquated as operations become larger and more complex. Let's look at it with a stop-and-go-light analogy.
Green light: Greater than 33 percent - If the producer has high debt levels, is moving into a major expansion, or is coming off a profitable cycle in the industry along with a good risk management program for young producers.
Yellow light: 10 to 33 percent - If higher equity above 70 percent or coming off a down cycle in prices, such as recently.
Red light: Less than 10 percent - Either extremely high equity more than 85 percent, a great risk management program, or frugal living.
Working capital can take a number of years to build up only to be used up in 6 to 10 months like during the last down cycle. With higher volatility in milk prices and input costs, this metric will become more important.
Sipiorski: A dairy operation should have $2 of current assets for every $1 of current liability. That would be called a 2:1 ratio. This means there should be two times the amount of current assets of cash, feed, and other current assets which will be turned into cash in the next 12 months compared to the current liabilities of bills owned and principal due in the next 12 months. A 1.5:1 ratio is about as skinny as dairy should go. This may seem like a lot of liquidity. But this is a safe level; think about how this kind of liquidity would have felt in 2009.
Where does return on operating expense need to be on a good operation?
Kohl: I also like the operating expense to revenue ratio (excluding interest and depreciation or corporate management fees). As for benchmarks:
Green Light: less than 70 percent
Yellow Light: 70 to 85 percent
Red Light: more than 85 percent
Thus, top level producers will have 30 percent margin. However, examine this over the years and through the cycles.
Sipiorski: On most dairies, an 85 percent expense rate is as good as it is going to get with the current market conditions. If it is possible for a dairy to lower their expenses below 85 percent, they will be a winner over others. Today's economics does not seem to be allowing dairy producers to capture any more than a 15 percent return.
For more information read the July 2010 issue, page 469
