Managing repayment of debt
As commodity prices have fallen and land values have increased, what must an agricultural producer do to assure cash will be available to repay debt? What are some strategies that can be used? To manage debt repayment capacity, one must set limits on either the amount of funds borrowed or on the operating decisions of the business. The purpose of these limits is to guarantee that adequate cash is available to repay debt. This article will discuss some examples of how to set limits.
Crop insurance is one way to cover a cash flow shortage from low yields. It is amazing the number of producers that do not buy crop insurance against catastrophic loss. On this same line, hedging on the futures market can be used as a type of insurance against low prices. When using futures contracts, find a marketer that you trust and are comfortable working with, and take advantage of any futures marketing classes offered by an elevator, marketing organization, extension, etc. The more knowledge a producer has about how markets work, the more comfortable he/she will become with the futures contract decision making process.
Another strategy many agriculture producers use is to maintain cash reserves equal to a specified percentage of existing debt obligation. Maintaining a reserve allows the producer to dip into the cash account to make payments if current operations come up short. This cash reserve is not the operating note; it would be in an interest bearing account that is readily available.
Another limit, or strategy, producers can use is to only borrow a specified percentage of the purchase price of capital items. In this way, a larger proportion of a capital purchase is financed with past earnings, which, in turn, reduces the demands placed on future earnings.
When it comes to feeder livestock, the recommended strategy is to borrow the purchase price of the livestock only if adequate feed inventories are available. If money is borrowed for feed and livestock purchases, a bigger return must be made on the cattle to cover the debt.
Some dairy producers assign a milk check, where a percentage of all proceeds are allocated by the processor or coop to make debt payments. This helps make payments on existing notes before a dairyman has the opportunity to use the money on discretionary spending.
The last strategy many producers use is forecasting revenues for the upcoming year, usually with a projected cash flow, and then establishing spending limits for each major operating expense category that is well below the projected income. By keeping operating expenses in check, the producer has more available money to pay down debt obligations.
Producers cannot plan for all expenses in a year but by having some management strategies in place, the unexpected expense problems are easier to handle. If any producer would like more information on record management, the SD Center of Farm and Ranch Management can help. To contact the SDCFRM office or any of our instructors, call 1-800-684-1969 or email us at email@example.com.