Today’s farm price environment requires changes in how business will be conducted compared to the past few years of higher commodity prices.
For several years producers enjoyed some stronger profit margins and in many cases large amounts of working capital funds were built up. Larger amounts of working capital funds allowed for producers to pay cash for many inputs such as seed, fuel, fertilizer and other required inputs. Several producers had excess working capital that was used to purchase equipment, buildings, trucks and other capital items.
Today many producers are in need of funds to purchase inputs and find working capital funds to be low. This is when lines of credit come into place as a credit tool to move forward with the business plan. There are many types of lines of credit and many thoughts on how to manage them. Typical lines are declining balance, revolving lines, vendor credit lines and capital lines.
Declining lines are often used for crop input loans. A set amount of funds is approved and disbursed as inputs are purchased. The line of credit is paid back at crop sale time, or with dairy producers, monthly payments are made to repay the loan.
Revolving lines are funded for a set amount and funds are drawn out when needed and repaid when funds become available for repayment. The borrower then can redraw funds as needed. Revolving lines of credit are a great tool but often lead to issues down the road.
Too often the loan funds are not paid back and the loan balance becomes a permanent balance. This becomes an issue at loan renewal time, and the lender and borrower begin to work to resolve the issue. Some lenders do require the revolving loan to be fully paid once a year. This requirement allows for better management of the loan and less likelihood of resolving a loan balance at renewal.
Vendor lines of credit is one other example of lines of credit. Often vendors such as supply cooperatives will give terms of 30 or 60 days to customers to pay a bill in full. When commodity prices drop, some producers will abuse vendor credit policies and not repay a vendor in the required time frame. This can lead to disputes, being cut off of supplies, legal actions and credit scores being damaged. Vendor lines of credit are not long-term lives of credit and often carry high interest rates.
Lines of credit are great tools for a business. But they need to be managed with thoughts of repayment and how to carry out a plan of repayment. In the consumer world there are credit cards and homeowner equity lines of credit. We have all experienced the pain when too many individuals get caught up in an environment of overextension of credit lines to consumers. This same environment can occur in the business world.
A plan for repayment for a credit line is a must and needs to be put into practice. Abuse of credit lines can harm the future of a business.
Other lines of credit to consider are capital lines of credit and emergency lines of credit. Capital lines could be established for replacement dairy animals or for farm equipment. In the past I have worked with several dairy managers who used capital lines to purchase cattle and then used the sale of culled animals or bull calf sales to repay the capital line.
It may now be a good time to consider the idea of establishing emergency lines of credit to use for only the times when working capital may come under pressure from low commodity prices. A suggestion may be $450 per dairy cow as a target number and that borrowers should be willing to pay a lender for setting up a line of credit that the producer would hope to never have to use.
*This article originally appeared in the Fond du Lac Reporter on July 11, 2015. Bob Panzer recently joined our team in the risk management department.*