 Discuss the importance of farm credit.  Explain three fundamentals of credit.  List eight rational credit principles needed for effective decision making.  Describe three areas for which credit is needed.  Differentiate the three lengths of financing terms.  Discuss the three types of loans.  Explain the components of a credit profile.  Compute interest.  List the agricultural credit sources for real estate and non-real estate loans.

 Credit decisions are most important judgment by business owners  Determine if businesses will make a profit  Sufficient financial resources must be available  Money is used in every area of agriculture industry

 Credit is needed to overcome a shortage of equity capital  Restricted capital, changing interest rates, and lack of credit information are major problems  Credit allows farmers to: › Increase production › Improve the quality of what is produced › Revise operations to make them more profitable

 Substitution of capital for labor  In 1900… › capital contributed 25% to the production process › labor contributed 75%  Today… › capital contributes 90% › Labor contributes 10%

 Ag products and services make up ¼ of the GDP in the US  In 2005… › Farm assets totaled $1.8 trillion › Real estate totaled $1.52 trillion › Non real estate totaled $210 billion › Financial assets totaled $67 billion › Total farm debt totaled $215 billion  Figure 7-2

 Returns › Borrow money to increase net returns › Will profit be greater by borrowing money?  Repayments › Principal plus interest › Farms usually posed as collateral › Foreclosure results from failure to repay  Risks › Strong assets = less risk › Weak assets = high risk › Lenders favor those who can absorb potential loss

 Agribusiness profitability based on several components › effective use of farm credit › right combination of land, labor, equity, management, and credit  Page 145, Principles for Success

 Financing is needed in three areas:  Fixed expenses › items that can be used over a long period of time and incur the same expenses each year › Land, buildings, machinery and equipment, etc.  Operating expenses › Everything needed to run a farm or agribusiness › Transportation, utilities and fuel, etc.  Startup expenses › payable before the business begins operation › attorney’s fees, incorporation expenses, development costs, etc.

 Lending stimulates economic activity by providing purchasing options that would otherwise be impossible to obtain  Loan is a contract between the borrower and the lender  3 borrowing time frames: › short-term › intermediate › long term

 Terms are one year or less  Main use is to finance operating inputs  Short-term operating loans are most common  Typical operating loan is for six months  Single payment retiring the loan amount at the end of the period  Suppliers of short-term loans: › Banks › Merchants › Individuals › Farm Credit Services

 Vary in length from 1 to 10 years  Finance assets that may be depreciable › farm machinery and equipment › breeding livestock › irrigation systems  Suppliers of intermediate loans: › Commercial banks › Farm Credit Agency  May take collateral and liens on property to ensure repayment of loan

 Extend over 10 years  Used when buying: › Land › Buildings › Housing  Agribusiness start-up depends on these loans  Suppliers of long term loans: › Farm Credit Services › Commercial banks › Life insurance companies

 Allows the borrower to acquire funding up to a maximum amount  Used to buy production inputs such as fertilizer, feed, or feeder calves  Must be repaid completely within one year

 Allows producer to borrow up to specified limit  Loan amount fluctuates with seasonal credit requirements  No need to be completely paid off as long as adequate collateral is available  Generally more expensive than other loans  More flexible than other loans  Yearly renewals and increases are also available

 Specified amount loaned for a specific amount of time  Paid off with a single payment or scheduled payments consisting of principle and interest  Detailed loan agreements generally accompany these loans

 Credit profile required with loan application  Want positive answers to the following questions: › Personal characteristics › Management ability › Financial position › Loan purposes › Loan security  Figure 7-6 for example of application

 Interest can be a major expense  Represent price charged for use of money  Supply & demand influence rates  Often fluctuate over time  Interest is “selling price” of loan to the buyer  Calculating interest is essential to controlling the cost of capital

 Difference between amount paid for loan and amount received from it  For example… › Borrow $100 at 9% interest › 100*.09 = $9 › Cost of capital is $9  APR (annual percentage rate) is a common name for the actuarial interest rate  3 ways to calculate APR

 Applies to loans with a single payment  Example is a 6-month, short-term operating loan  APR is the rate charged if no down payment or borrowing fee is required › Previous example, APR was 9%  Page 153 › Remaining Balance Method › Add-on Method

 Chart used to calculate the constant payments needed to repay principal and interest  Amortize - loan set up with equal installment payments › annual › semiannual › quarterly › Monthly  Figure 7-7, left column

 Loan that generates enough after-tax income to pay for itself  Has a positive cash flow during loan period  Many ag investments show a negative cash flow during the first years of activity  Difference must be made up from profits in other parts of the operation

 Determining if benefits (income) outweigh costs (investment)  Benefits must be determined and divided by the costs  Useful management tool for making investment decisions  For example… › $110 benefit/$100 cost = 1.1 profitability index

 Agricultural lending is big business  Major credit sources for agricultural industry: › Farm Credit System › commercial banks › Farm Service Agency (formerly FmHA) › Commodity Credit Corporation › life insurance companies › individuals

 Money used to finance farm expansion and higher-cost production items › farm machinery › motor vehicles  In 1995, non-real estate loans totaled $72 billion › commercial banks supplied 50% › Farm Credit System supplied 17% › Farm Service Agency supplied 5% › Individuals supplied 21%  Figure 7-9

 In 1998, real estate loans totaled $87.6 billion › Farm Credit System supplied 32% › life insurance companies supplied 11% › commercial banks supplied 31% › Farm Service Agency supplied 5% › individuals supplied 24%  Farm Credit System is the largest lender involved in the land mortgage field