# How much debt can I repay _1_

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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
•    Evaluate repayment margin with
respect to:
1) Risk
2) Borrowing power
3) How to structure debt financing
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

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
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

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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