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					   Strategic Business Planning for Commercial Producers




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




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




How to Measure?

• Term Debt Coverage Ratio
• Term Debt Repayment Margin
    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
    Strategic Business Planning for Commercial Producers



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

Worksheet 3. (Continued) MBC
Farms
 Term Debt Coverage Ratio
 11. Term debt repayment                         $ 259,354
 capacity
 12. Principal and interest                              $
 payments on term debt                           170,805*
 13. Term debt coverage ratio                   (=) 1.52:1
 (11/12)

 *Principal paid = $80,997 + interest expense on
 term debts = $89,808
 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
     Strategic Business Planning for Commercial Producers



  Worksheet 3. continued
  MBC Farms
Term Debt Repayment Margin
20. Term Debt Repayment Capacity                    $ 259,354
21. Principal + interest on term debt               (–) 170,805

22. Term debt repayment margin                      (=) 88,549
  Strategic Business Planning for Commercial Producers



How Far Can I Stretch Margin Dollars
For New Capital Purchases?

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


 Example of Margin of Safety
 Management – MBC Farms
                                            Actual    Forecast

                                                 $
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 –         259,354
5)
7. Term debt principal and interest        170,805
payments
8. Term Debt Repayment Margin (6 –          85,549
       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 farm’s 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
     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 today’s 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?
     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
      Strategic Business Planning for Commercial Producers


How Would You Respond?
First Scenario – The farm’s asset turnover ratio and
  operating profit margin are exceptionally high; but,
  the farm’s term debt repayment capacity and
  margin are $98,000 and $(15,000) respectively. The
  farm’s term debt coverage ratio is .867:1. The
  farm’s 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?
      Strategic Business Planning for Commercial Producers


How Would You Respond?
Second Scenario – The farm’s 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?
      Strategic Business Planning for Commercial Producers


How Would You Finance This Investment?
Third Scenario – The farm’s forecast term debt
  repayment margin for this year is $190,000 and the
  farm’s 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 farm’s 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?
     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
   Strategic Business Planning for Commercial Producers




Strategic Business Planning for
Commercial Producers
  Strategic Business Planning for Commercial Producers



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                        $

				
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posted:2/24/2011
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