How to Finance a Small Farm
By Karen Klonsky, Extension Specialist, University of California, Davis
The cost of borrowed capital is a significant part of most growers' budgets. Producers should shop for loans just as they look for the best price for fertilizer, seed, and all other production inputs. Deregulation in the banking industry has increased competition, which has caused more precise pricing of loans. This means that banks are competing with each other for good loans by offering lower interest rates, lower loan fees, or other services. More than ever it is important to compare loans carefully. Nothing is more important when working with a lender than being prepared. About the worst thing you can do is go into a banker's office and as, "How much can I borrow?" This shows the banker that you do not have a budget or any clear understanding of your cash needs. Your overall business plan along with several other documents can serve as explanation of your borrowing needs and repayment ability.
Documents You May Need to Provide
There are several documents that you should be prepared to provide when applying for a loan. First, put together a resume describing your background; include experience working on other farms and your education. Next, make copies of your income tax returns for at least the last three years.
Put together basic financial statements for each of the last three years. These include a balance sheet which lists all of your assets and liabilities (money you already owe). Be sure to include cooperative retains and any money that is owed to you in your list of assets. The next financial statement is the income statement, which is a profit and loss statement for the past year developed on an accrual basis. Finally, develop a cash flow budget that shows your sources and use of funds on a monthly basis for the past year at least. Also prepare a cash flow budget for the coming year to clearly illustrate your expected cash needs.
Other documents you may be asked to provide include titles to real estate and personal property particularly if these assets are securities for the loan. Include serial numbers and identification of any new equipment purchases. Provide a list of terms and conditions of any outstanding loans including whom the loan is with and any account numbers. List all collectible notes and accounts receivable including dates, entities involved, and terms of the agreements. You may also be asked to provide a third party opinion on the yield and value of growing crops if they are listed as assets.
Any crop loan application must include a map of the fields and cropping plans for the farm operation. Include any lease agreements so that it is clear what crops are to be grown where, what the ownership status is for the properties to be farmed, and what the cash rent or crop-share agreement is.
Insurance policies for equipment, liabilities, and crops may be a requirement for the loan. Be prepared to provide complete insurance information including carrier, policy number and amount of coverage.
A marketing plan is another essential part of a loan package. Include any sales contracts you might have and co-op membership if applicable. A plan is critical for the bank to evaluate your proposal. A marketing plan shows you've done your homework and understand the industry situation for the crops or livestock you're producing. A detailed marketing plan is particularly important for a new or unusual commodity. Be fairly conservative in your planning, so that there is a margin for unforeseen setbacks.
Questions To Ask Lender
There are several questions you should ask a lender when applying for a loan. Ask if real estate is a security. If so, is there an appraisal fee? Also ask if there is an application fee or commitment fee and if it is returned if the loan is made.
There may also be closing costs, inspection fees or charges for documents that may be recorded. Be sure to find out if these costs have to be paid by you and whether or not they have to be paid up front. Be sure to ask if any of these fees can be paid as part of the loan or if they must be out of pocket expenses. This may significantly affect your cash flow. Ask if compensating balances in the form of a minimum balance in a checking account or savings account can be used to reduce the cost of the loan.
Questions A Lender May Ask
There are several questions you should be prepared to answer. The lender may want to know if you are a co-signer, endorser or guarantor for debts incurred by others. Questions about income tax owed on assets already sold or income received should be expected. This information should show up on your balance sheet and income statement. Be prepared to explain your involvement in any lawsuits. The lender will ask you about your marketing strategy and whether or not you are guaranteed a home for your product. Explain the details of any contracts. The lender may ask about compliance with state and federal laws regarding labor, pesticides, water runoff and other areas. Many lenders are starting to use an environmental questionnaire to be completed by the loan applicant to determine if further investigation is necessary. In order to complete the questionnaire, the applicant must know the history of the property being farmed. For example, questions may be asked about the existence of underground fuel tanks, prior use of herbicides and pesticides and past pollution problems on the property. Compliance with laws that affect your farming operation should be a part of your overall plan. You may also be asked about your long-range plan for your operation including changes in crops, size of operation or ownership. Mention any pending sales or purchases of assets.
There is no substitute for a good working relationship with your lender. Creative financing such as restructuring a loan, refinancing or rolling over production loans are done at the discretion of the lender and not as a matter of course. A long-term relationship with a lender increases your financing options. Financing is critical to any farming operation. Remember that complete and accurate records are the building blocks for any financial decision.
Sources of Credit and Information
Beginning farmers are often precluded from loans because they do not have enough risk-bearing ability or experience. Risk-bearing ability translates into collateral or equity. A lender wants to have some recourse if something goes wrong. When a lender provides financing for your farming operation, it is essentially a business partnership. The lender wants you to put some money or assets up front. The most common way to meet the collateral requirement is to have a co-signer for the loan who can provide the required collateral.
After the collateral requirement is met the lender wants to know about your farming experience and track record. This should show up in your resume.
The Farm Credit system is comprised of three different banks: the Production Credit Association (operating and equipment loans), the Federal Land Banks (loans for farm real estate), and the Bank for Cooperatives (loans to farm cooperatives). Farm Credit System offices are located throughout California. There is a "Young, Beginning, and Small Farmers Program" that consists entirely of financial counseling. This is a good place to get an insider's opinion of the strengths and weaknesses of your loan application before you actually apply for a loan, starting with your local Production Credit Association office.
The USDA's Farm Service Agency (FSA) makes and guarantees loans and provides credit counseling and supervision to farmers and ranchers who are temporarily unable to obtain private or commercial credit. These may be beginning farmers who cannot qualify for a conventional loan because of insufficient net worth or established farmers who have suffered financial setbacks. These loans are tailored to producers needs and may be used to buy farmland and finance agricultural production, equipment, and livestock. Limited resource borrowers may also qualify for subsidized interest rates.
To find out how these programs can work for you, visit or stop in at the local Farm Service Agency or USDA Service Center office. The locations of these offices can be found by looking under U.S. Department of Agriculture, Farm Service Agency in your local telephone directory. In some cases, you may find the offices still listed under the former Farmers Home Administration (FmHA) or Agricultural Stabilization and Conservation Service (ASCS).
In addition to FSA and the Farm Credit System, there are regional development corporations in California that make loans, or guarantee loans, to small businesses under the auspices of the California Office of Small Business. One of them, California Rural Coastal Development Corporation (Cal Coastal), makes loans to farmers using the FSA loan guarantee program. The maximum loan amount is $350,000. California Coastal serves the region from Santa Clara to Santa Barbara. For more information, contact:Cal Coastal
East Gabiln Street, Suite 218
Salinas, CA 93902
Obtaining capital for small-scale farms requires preparation by the borrower before applying for the loan. The most important thing to remember is that the lender wants assurance that the borrower can repay the loan. Conveying the image of a diligent, well informed, experienced businessperson will greatly enhance your ability to obtain credit. There is help available through state and federal agencies. Make use of it.
Documents you may be asked to provide when applying for a loan:
- Resume - applicant's background and experience
- Income tax statements - usually three years
- Financial statements for each of the last 3 years
- balance sheets
- income statement
- cash flow statements
- Titles to real estate and personal property items (such as machinery), particularly if these assets are securities for the loan
- Serial number and identification for new equipment purchases
- Terms and conditions of outstanding loan - who the lender is and account number
- Collectible notes and accounts receivable - listed and dated, source and terms
- Third party opinion on quantity and value of growing crops if they are listed as assets
- Map of fields/cropping plans
- Lease agreements for properties to be farmed
- Insurance policies
- Sales contracts
- Business plan including marketing plan, long-range changes, pattern of ownership, planned purchases and sales of asset
Questions to ask lender:
- Appraisal fees - if real estate is a security
- Application fee or commitment fee - ask if fee is returned if loan is made, or not returned if loan is not made
- Closing costs, inspection fees, or charge for documents that may be recorded - most out of pocket costs for loan are paid by borrower
- Can fees be paid as part of the loan or must they be paid in cash up front?
- Compensating balances - ask if maintaining a bank account can reduce the cost of the loan
Questions a lender may ask:
- Are you a co-signer, endorser or guarantor for debts incurred by others?
- Do you owe income tax on income received or assets already sold? This should show up on balance sheets and income statements.
- Are you involved in any pending lawsuits?
- Are you involved in any contracts? What are the liabilities if you fall short of your contract? Are you guaranteed a home for all products? Do you have an established market?
- Is there potential liability in connection with violation of local state or federal regulations? Have there been any pollution problems on the property?
Terms for analysis of financial situation:
- Modified cost basis = Takes out impact of inflation by using actual cost of assets. Disguises solvency of business.
- Market value = What is asset worth today? Includes inflation of land as an increase in net worth.
- Liquidity = Ability to produce cash.
- Current ratio = Current assets / Current liabilities
The current ratio should be at least 1:1. This means that you have a dollar in liquid assets for each dollar you will need to pay in the next 12 months.
- Working capital = Current assets - current liabilities
- Leverage = Total liabilities / Net worth = Debt / Equity
When this ratio is greater than one, the lender has more invested than the borrower.
- Net capital ratio = Total assets / Liabilities
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