Debt load details to know
Inflation, soaring commodity and input prices, interest hikes – the last two years have featured a lot of financial pressures. While these and other factors can have a direct impact on debt management, proactively reviewing and re-assessing farm debt levels can help operators weather storms, as well as seize opportunities.
What’s my debt service coverage ratio?
The debt service coverage ratio (DSCR) measures your business’ ability to pay down debt – that is, the net income available for all debt obligations (principal and interest) in a given year.
This can be found in one of two ways:
- Net farm income after taxes plus term interest and depreciation, minus drawings (living expenses).
- Dividends plus net off-farm income. Depreciation (or capital cost allowance) is added back in because it’s not a cash cost.
Both short-term debt and the current portion of long-term debt that will be due are included in the calculation, including interest. A DSCR of 1.5 is considered healthy, while a ratio below 1.0 indicates a difficulty in servicing debt.
Ted Oke, senior relationship manager at FCC in Clinton, Ont., says farm operators can anticipate how changing factors will affect their ability to service debt by analyzing multi-year projections and historical data.
“Instead of reacting, we can be proactive. Personally, I like to observe longer than a three-year period of financial results. We’re involved with account reviews and benchmarking to see if there are trends on any expenses, like climbing operating costs. It makes a big difference on the availability of cash,” Oke says.
“Are we discussing something already part of the business, or is it a new opportunity? Look at the revenue to come, and what the financing will cost. Today, people are investing in very few things in agriculture that are not being subsidized with some other source of income.”
Anticipating loan renewal
Analyzing interest rate trends is critical.
Analyzing interest rate trends is critical, says Oke, because it helps loan holders stay flexible during renewals. Doing so can mean looking out for potential increases in federal interest rates and asking financial advisors about current trends. Knowing the trends means anticipating interest hikes, making use of longer loan periods or switching from variable- to fixed-rate interest structures at opportune times.
“You don’t want to be in a situation where all of a sudden all your loans come up for renewal at the same time, with rates three points higher from the last time you renewed,” Oke says. “Staggering terms spreads out risk. What loans do you have coming up, and does it make sense to look at rates if you were to renew ahead of time?”
Identifying opportunities to increase cash flow can also be helpful if there is capacity to service higher debt.
“It might be a good time to look at your operating needs and bump up your line of credit limit to capitalize on things like seed and early order discounts, pre-paying crop inputs – take advantage of those opportunities. You’re spending more dollars to run the same acres.”
From an AgriSuccess article by Matt McIntosh.