Managing banking relationships in agricultural organizations
For many agricultural organizations, their chosen financial institution is a significant partner in the success of the operation. With increasing consolidation of farm corporations, credit facility agreements are becoming larger and more complex. Reporting frequency has increased, covenants have been added, and many institutions are seeking forward-looking projections. Adding to this pressure is the increasing cost of many agricultural inputs combined with increased scrutiny due to tighter cash resources. Consequently, an agricultural organization’s relationship with its financial institution has become more important than ever. Some key guidelines and strategies can help organizations to manage that relationship.
Report on time
When financial institutions define “default,” they tend to include more than simply missing a payment or not paying a debt that is owed. In the fine print, most credit facility agreements cite late reporting as a default as well. Reporting on time is one of the easiest ways for an agricultural organization to maintain a harmonious relationship with its bank.
Know the negative covenants
Many producers sign credit facility agreements and then never look at them again. As a result, many overlook the negative covenant clauses detailing when the producer is required to seek bank approval for distributions. Approval often is required in connection with capital assets, shareholder distributions and related-party transactions.
No surprises!
Few who work in accounting and finance are fans of surprises. When covenant testing is completed annually, the first indication that the organization is offside often appears with the accountant-prepared financial statements, issued anywhere from 90-120 days after year-end. If a financial institution learns of a breach from a note disclosure on the financial statement issued months after the fiscal year-end, the organization will have some significant explaining to do.
The situation is similar for operations during the year: because of the seasonality of many agricultural sectors, there are peaks and valleys in cash resources and draws on operating loans. Grain farmers have seen astronomical increases in inputs recently, putting pressure on margins and overall limits through the spring and summer. A Chinese proverb says, “the best time to plant a tree was 20 years ago and the second-best time is now.” If an organization expects to need more cash through the spring and summer, the best time to discuss with its financial institution is now. Increasing limits or approving temporary bulges requires several levels at the financial institution and is not an overnight process. Being proactive will help.
Focus on the future
A forward-looking cash flow projection is one of the most powerful financial tools an organization can have. Several factors are relevant when creating a cash-flow projection.
Real-time data
It is difficult to consider the future if you do not know where you are starting. The first step in the process is to bring accounting records up to date. With advances in cloud accounting systems and related apps, having real-time data is easily attainable for any agricultural organization.
Consider the balance sheet
Many organizations have profit and loss projections, or budgets. While those steps represent an excellent start, the balance sheet should be incorporated into the projection for two key reasons:
- From a timing perspective, cash expenditures in agriculture often do not line up with cash collections. For example, fertilizer might be purchased several months or even a year in advance of harvesting and marketing grain. It is important that this cash outlay is built into the projection when it happens, rather than on an accrual profit and loss budget.
- Many agricultural organizations have significant cash transactions that do not flow through the profit and loss statement, including capital expenditures, debt repayments and inventory purchases. These large, lump-sum amounts must be considered.
Once the projected balance sheet is built, the producer will have a clear picture of where the peaks and valleys are in their cash or overdraft balance, helping to highlight any pinch points that should be discussed with the financial institution.
Furthermore, the projected balance sheet will include projections for accounts receivable and inventory. As these two items are the main drivers for margin calculations, a projected margin limit can be calculated and compared to the cash needs for that period. Doing so will highlight any months in which the organization may be out of margin.
Projected covenant calculations may also be completed, such as debt service, fixed charge coverage ratios, or debt to tangible net worth. Again, the goal here is proactive communication with the financial institution of any potential breaches.
Compare actuals to projected
Once the real-time data and projections are established, it is important to re-visit them on a monthly or quarterly basis. The agriculture industry is volatile; assumptions change by the minute. Comparing actual results to what was projected can highlight the following concerns:
- Blind spots or items missed ─ The projection will forever be a work in progress. In the first few attempts, there will undoubtedly be items that were missed or overlooked.
- Changing assumptions ─ Projections are the best estimate of what will happen based on current knowledge. Fast forward a month or a quarter and those assumptions—especially when it comes to market prices—can change significantly.
Put it to the test
A good projection is nothing if you do not try to break it! Ideally, a projection should be built in a way that the assumptions can be easily manipulated, for example by adjusting metrics such as yield, price, interest rates and foreign exchange. It is helpful to “stress test” the organization to pre-emptively answer those “what if” questions.
Focus on strengths
So, as a producer, how do you manage the increasingly complex banking relationship and run your organization too? The answer is, you don’t. Your strengths lie in running a successful and efficient operation. At Baker Tilly, our strengths lie in managing data and accounting. We work in hours so you can work in acres. Contact your Baker Tilly team to discuss how we can help.
Meet the Author
Candice McKay
Information is current to December 10, 2021. The information contained in this release is of a general nature and is not intended to address the circumstances of any particular individual or entity. Although we endeavour to provide accurate and timely information, there can be no guarantee that such information is accurate as of the date it is received or that it will continue to be accurate in the future. No one should act upon such information without appropriate professional advice after a thorough examination of the particular situation.