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