KNOW YOUR LENDER'S MEASUREMENT CRITERIA

Originally published on February 18, 2010

 

A banker called me to review a farmerís financial information. He appreciated the additional ratios and other per acre measurements that were attached as a supplementary to the grain farmerís financial statements.
In our discussion, he suggested we keep track of one other measurement: principal and interest repayments per acre.
According to this banker, farmers should target their principal and interest repayments per acre to be at or less than $25.
He also said the 10-year average profit per acre, before principal and interest payments, is about $50 on most productive farms. This is his simple rule-of-thumb, he added. Some farms do better and others do worse.
I called another banker, who offered another opinion. He said the $25 per acre measurement for a farmersí total principal and interest loan repayments was low and added his bank liked to see the number under $50.
I ran some numbers from our client base to see where we stood.
The sample of grain farms was diverse, ranging from 1,475 to 6,300 acres. Most of them practiced minimum or zero tillage, but a few were half-and-half farmers, meaning only one-half of their land was seeded each year, with the remaining left in fallow.
Our sample of farmers grew lentils, canola, wheat, barley and durum.
They were all incorporated and filed their financial statements on an accrual basis with minimal commodity inventory adjustments from one year to the next.
To measure our profit per acre, we added the following back to the farmís net income: amortization, interest on long-term debt, management remuneration and income taxes.
The farmers in our sample group reported a two-year average profit of $122 per acre, a three-year average farm profit of $94 per acre and a five-year average farm profit of $77 per acre.

 

It was easy to see the significance of a good year. One farmer, with everything going right, reported our highest profit per acre of $158.
This occurred after a drought year in which his profit was $49 per acre, bringing his two-year average to $103 per acre.
Using the same sample of farmers, we calculated our principal and interest repayments per acre as a five-year average to be $36.
These are profitable farms that any small business owner would envy and that our first banker, whose lending criteria was to keep this measurement under $25 per acre, would most likely send elsewhere.
The principal and interest repayments per acre might also be used to help farmers in their farmland lease-versus-buy decisions.
For example, if buying farmland results in a principal and interest repayment per acre that is lower than the cash rental per acre, a farmer would be tempted to buy the farmland.
The logic is, why rent if you can buy it on a lower per acre basis.
Farmers who have leased and owned land will have to modify their calculations to obtain an accurate measurement.
They would need to exclude the farmland lease payments in the calculation of profit and include them in the total of principal and interest repayments. The lease acres would then be included in the total acres.
The principal and interest repayment per acre is a useful tool that farmers and lenders can use.
From a lending perspective, it appears the measurement criteria among financial institutions is different, with some bankersí rules of thumb being more conservative than others.
For this reason, farmers should know their own numbers and their bankerís rule of thumb.

 

Allyn Tastad, certified general accountant, is a partner in the accounting firm of Hounjet Tastad Harpham in Saskatoon at 306-653-5100, e-mail at allyn@hth-accountants.ca or website www.hth-accountants.ca. He is also involved in the family farm near Loreburn, Saskatchewan.  The opinions expressed in this column are for information only.