1. Strategic Business Planning for Commercial Producers Debt Service Analysis: Can I Repay?

2. Strategic Business Planning for Commercial Producers Objectives Measure term debt repayment capacity, margin, and coverage ratio on your farm Evaluate repayment margin with respect to: 1) Risk 2) Borrowing power 3) How to structure debt financing Think about operational strategies for managing debt repayment capacity

3. Strategic Business Planning for Commercial Producers How Much Debt Can I Repay? Depends on –Repayment capacity –Interest rate –Repayment period for borrowed money

4. Strategic Business Planning for Commercial Producers How to Measure? Term Debt Coverage Ratio Term Debt Repayment Margin

5. Strategic Business Planning for Commercial Producers Term Debt Repayment Capacity Measures the dollar amount of net income available for servicing term debt Uses: Step 1 in computing both the term debt coverage ratio and term debt repayment margin Estimate maximum safe farm debt load

6. Strategic Business Planning for Commercial Producers Worksheet 3. MBC Farms Term Debt Repayment CapacityMBC Farms 5. Net Farm Income (Item Z)$ 280,519 6. Interest (Item X minus operating interest) (+) 89,808 7. Depreciation (Item C)(+) 136,922 8. Family Living Expenses & Taxes (Item V) ( – ) 150,000 9. Income for debt + replacement (5+6+7- 8) (=) 357,249 10. Cash used for capital replacement ( – ) 97,895 11. Term debt repayment capacity (9–10)(=) 259,354 Alphabetical items in parentheses refer to worksheet 1.

7. Strategic Business Planning for Commercial Producers Worksheet 3. (Continued) MBC Farms Term Debt Coverage Ratio 11. Term debt repayment capacity$ 259,354 12. Principal and interest payments on term debt $ 170,805* 13. Term debt coverage ratio (11/12) (=) 1.52:1 *Principal paid = $80,997 + interest expense on term debts = $89,808

8. Strategic Business Planning for Commercial Producers Term Debt Repayment Margin Measures how much term debt repayment capacity remains after already existing term debt payments have been made Used to: Evaluate the ability to acquire capital assets or service additional term debt Decide how to structure additional financing Evaluate the margin of safety associated with servicing term debt

9. Strategic Business Planning for Commercial Producers Worksheet 3. continued MBC Farms Term Debt Repayment Margin 20. Term Debt Repayment Capacity 21. Principal + interest on term debt $ 259,354 (–) 170,805 22. Term debt repayment margin(=) 88,549

10. Strategic Business Planning for Commercial Producers How Far Can I Stretch Margin Dollars For New Capital Purchases? MBC Farms 1. Term Debt Repayment Margin $ 85,549 2. $ mount required to amortize $1 of term debt over 4 years at 7% 0.29523 3. Additional debt that could be paid (1 ÷ 2) $ 289,771

11. Strategic Business Planning for Commercial Producers Term Debt Repayment - Margin of Safety How much can gross revenues fall before repayment capacity is lost? Term Debt Repayment Margin serves as a buffer against risk. How big should this buffer be?

12. Strategic Business Planning for Commercial Producers Example of Margin of Safety Management – MBC Farms ActualForecast 1. Gross Farm Revenues $ 1,796,651 2. Net Farm Income + Depreciation 417,441 3. Interest on Term Debts 89,808 4. Family Living Expenses 150,000 5. Cash used for capital replacement 97,895 6. Repayment Capacity (2 + 3 – 4 – 5) 259,354 7. Term debt principal and interest payments 170,805 8. Term Debt Repayment Margin (6 – 7) 85,549 9. Repayment Margin of Safety Ratio (8 ÷ 1) 4.9%

13. Strategic Business Planning for Commercial Producers What is a safe margin? Critical Cash Flow Analysis Critical cash flow is the minimum $ amount of gross income required to meet the farms needs to pay all of the following: 1.Cash operating expenses & interest on operating loan 2.Scheduled principal & interest payments on term debt 3.Withdrawals for family living expenses & income tax 4.Cash needed for planned reinvestments in the farm

14. Strategic Business Planning for Commercial Producers Managing The Term Debt Repayment Margin Repayment margin is more than adequate How to use the excess? How to structure debt that will be serviced with the excess? How todays decisions will affect this and future years? Repayment margin is not adequate How to increase the repayment margin or reduce the risk of a shortfall?

15. Strategic Business Planning for Commercial Producers Operational Strategies For Managing Repayment Capacity Repayment management has traditionally focused on minimizing debt relative to total assets, managing the terms and conditions of loans, and other financial strategies The amount of debt that can be managed safely can be increased by focusing attention on operational strategies for managing repayment capacity Operational strategies focus on making decisions and establishing policies that increase the likelihood that the necessary income will be available to make payments as they come due

16. Strategic Business Planning for Commercial Producers How Would You Respond? First Scenario – The farms asset turnover ratio and operating profit margin are exceptionally high; but, the farms term debt repayment capacity and margin are $98,000 and $(15,000) respectively. The farms term debt coverage ratio is.867:1. The farms solvency ratio (debt to assets) is 25%. A. improve financial performance B. expand operation C. alter debt repayment terms How might you restore debt repayment capacity on this farm?

17. Strategic Business Planning for Commercial Producers How Would You Respond? Second Scenario – The farms expected term debt repayment margin is too small given the history of income variability on the farm. Tripling the forecast term debt repayment margin will still leave the farm highly exposed to the risk of a decline in net income sufficient to wipe out the expected repayment margin. A.improve performance B.expand operation C.alter financial structure What operational strategies might a farm in this situation pursue to reduce the risk?

18. Strategic Business Planning for Commercial Producers How Would You Finance This Investment? Third Scenario – The farms forecast term debt repayment margin for this year is $190,000 and the farms margin of safety requirement is $135,000. On October 1 of this year the farm manager has $200,000 in cash on hand and is considering paying cash to make improvements to the farms grain handling and storage systems. 1) How much of the $200,000 is actually uncommitted and available to pay on the grain handling improvements? 2) What recommendations would you make about how to pay for the improvements to the grain handling system?

19. Strategic Business Planning for Commercial Producers Summary Debt is a valuable tool for fueling growth if managed wisely Repayment capacity is dependent on the ability to generate net income Repayment capacity is heavily influenced by repayment terms, and the need for net income to support family living and capital investment Use operational strategies to enhance the management of repayment capacity. How much repayment margin is needed and what to do with excess margin are important questions for the farm general manager.

20. Strategic Business Planning for Commercial Producers

21. Loan Computations (see Table 4 in EC-712 for the amortization factors) amount borrowed$ x amortization factor$ = loan payment amount$ or loan payment amount$ ÷ amortization factor$ = amount borrowed$