Repayment Sources for A Farm Loan
When a lender analyzes your financials for real estate or some other term loan, they will closely examine your repayment sources for that loan. Several years ago, Dr. David Kohl, professor emeritus at Virginia Tech University and popular speaker and writer in the ag finance world, shared a clever way to think about repayment sources. He compared farm loan repayment to a defensive lineup on a football team. Here is a quick overview of what he shared to explain why your loan officer cares so much about cash flow and working capital.
The First Line of Defense – Cash Flow
In football, the first line of defense is the defensive line, made up of the tackle and defensive end. These players' job is to quickly stop ball movement and keep the offense from the first down. If the goal line is your farm, the defensive line of your operation is your cash flow. When cash flow is sufficiently strong, you can keep the offense team – your lender and suppliers paid. You meet your obligations easily, and your farm prospers.
Cash flow is the first source of repayment and the first line of defense.
The Second Line of Defense – Working Capital
The second line of defense in football is the linebackers. Linebackers are strong, fast, and can react quickly. They halt ball movement when it has penetrated the defensive line. The linebackers of your farm are your working capital. If working capital is available and robust, it can shore up your operation when cash flow is weak. If you don’t have the cash to meet your obligations, your working capital goes to work.
Working capital is the secondary source of repayment and the second line of defense.
The Third Line of Defense – Owner Equity
The final line of defense in football is the safety. They are the safety net when the ball moves past the defensive line and the linebackers. They stop the progress before things get out of hand but in a last-ditch effort. The safety of your farm is the owner's equity. You should have strong equity, but if it is a source of repayment, your operation is stressed. When losses are incurred and working capital runs out; you can shore up the operation through equity.
Owner equity is the third and final line source of repayment and the final line of defense.
This analogy provides a great visual to consider the financial strength of your farm and your strength as a borrower. Next time you are slugging through your financials, preparing for a meeting with your lender, consider your sources of repayment as your defensive strategy.
