Managing Credit and Cash Flow During Low Prices

John Bancroft - Market Strategies Program Lead/OMAFRA. With the current low prices and the poor price outlook for the next few months, developing an acceptable cash flow will be challenging.
calendar icon 22 February 2008
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When faced with market prices falling below the cost of production it is important to continue to manage your cash flow, credit arrangements, production flow and marketing plan. Small improvements can provide encouraging financial gains in the short run that may pay off in the long run.

A critical item to examine is the ability of the farm business to meet its cash obligations over the upcoming months. Develop a plan of action and communicate with your creditors the details of your current situation. Provide lenders with an assessment of your cash flow and credit needs. Negotiation of payment terms or restructuring may be options to deal with the unforeseen cash flow reductions and losses. Be proactive by taking action now rather than reactive when payments are past due. Loan payments that go into arrears could affect your credit rating and result in higher loan interest charges and future difficulty with loan renewals and requests. Deferral of payments can keep your loans in good standing and maintain an acceptable credit rating.

Feed, fuel and other input purchases carried for more than 30 days on account with suppliers may be subject to interest charges of two percent or more per month. Discuss your current situation and limits with your suppliers. Check the costs of carrying increased trade account balances compared to options which may be available through bank operating loans or the Advance Payment Programs.

Negotiate for an increased operating loan limit based on your cash flow analysis and marketing plan. If negotiating to increase your operating loan limit is not a realistic option, an alternative may be to term out a portion of your operating loan to free up additional working capital. Another option may be to negotiate for a deferral of existing principal payments on your term debt and make interest only payments for a period of time. Be prepared for the possibility of increased security being required by your lender. Reamortization may be an option used where there is a need to reduce the annual payments of principal and interest required on a term loan(s). This is accomplished by increasing the length of the remaining amortization (payback period) to allow more time over which to repay the remaining loan balance. It will assist your cash flow for the extended payback period of the loan, however total interest costs will be increased.

Lenders make credit decisions based on several factors. These factors normally include an assessment of standard components referred to as the "5 C's of Credit". The 5 C's are character, capacity, collateral, commitment, and conditions. An understanding of these factors may be helpful in discussions with lenders.

Character includes an assessment of the client’s production, planning and financial management skills. Consumer credit reports scores may be included in this assessment. These reports include bank, credit card and trade account payment ratings, which can be negatively affected by decreased cash flow. Capacity is the component that considers things such as past and projected debt service capacity relative to debt service requirements, past and projected operating expense ratios, cost of production, break-even analysis, and capital expenditure history. Reduced revenues and increased expenses due to low market hog prices will negatively impact these ratios which measure the client’s ability to cover costs and make loan payments. Collateral are the items is used to secure a loan. Loans secured by livestock may be impacted by lower market values of these assets. Tighter loan to security ratios may result in loan restrictions or additional security being required by the financial institutions. Commitment is the factor that assesses how much of the operation is owned by the client. It is measured by net worth and debt to equity calculations. Conditions include an assessment of the whole pork industry and how it impacts on the individual operation. This could include market options, environmental concerns, food safety items, trade issues, price volatility, currency fluctuations, and land value trends.

The bottom line is to recognize the current situation, develop possible solutions, seek assistance, and keep the communications open with everyone involved.

December 2007
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