University of Houston-Victoria Small Business Development Center Pat Calhoun - Instructor
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FARM LOANS FOR FARM LOANS FOR DUMMIESDUMMIES
Last year we taught you how Last year we taught you how to read ‘em, this year will to read ‘em, this year will
teach you how to build ‘em!teach you how to build ‘em!
University of Houston-Victoria
Small Business Development Center
Pat Calhoun - Instructor
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OBJECTIVESOBJECTIVES to understand the impact of agriculture on the U.S.
economy
to learn agricultural terminology
to understand cash flow and production cycles
to understand the financial mindset of the average producer
to review benchmark ratios and their calculations
to learn common FSA forms
case study
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ECONOMICAL FOOD ECONOMICAL FOOD SUPPLYSUPPLY
It takes about 40 days of income for most Americans to pay their annual food budget
It takes more than 100 days to pay their annual taxes
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MOST AFFORDABLEMOST AFFORDABLE
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AMERICAN FARMER AMERICAN FARMER IS:IS:
1997 – 32% age 65+ 1987 – 20% age 65+ 1978 – 15% age 65+
165,102 farms operated by women
Median age of all women on farms is 53.
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U.S. FARM U.S. FARM LANDSCAPELANDSCAPE
Texas – 227,000 farms Missouri – 108,000 farms Iowa – 93,000 farms Tennessee – 91,000 farms California and Kentucky – 88,000 farms
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U.S. FARM U.S. FARM LANDSCAPE con’t.LANDSCAPE con’t.
Individual or family owned – 86% Family partnership – 9% Family-owned corporation – 4% Non-family corporations – 1%
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U.S. FARM U.S. FARM LANDSCAPE con’t.LANDSCAPE con’t.
Total land in farms was estimated 941.2 million acres in 2001 compared to 1.04 billion acres used for farming in 1980.
More than 24 million workers (17% of total U.S. workforce) produce, process, and sell the nation’s food and fiber.
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U.S. FARM U.S. FARM LANDSCAPE con’t.LANDSCAPE con’t.
Small farms:
annual sales < $100K– 84% of all farms
– 35% of farm debt
– 13% of total farm sales
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U.S. FARM U.S. FARM LANDSCAPE con’t.LANDSCAPE con’t.Commercial farms:
annual sales > $100K
– 16% of all farms
– 65% of farm debt
– 87% of total farm sales
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PRODUCTIONPRODUCTIONToday’s farmer produces enough
food and fiber for 129 people.
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PRODUCTIONPRODUCTIONToday’s farmer produces enough
food and fiber for 129 people.
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ENVIRONMENTAL ENVIRONMENTAL PROTECTIONPROTECTION
Erosion rate by water on cropland has been reduced by 32% since 1982.
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FOOD DOLLARFOOD DOLLAR
Farmers and Ranchers receive only 19¢ out of every dollar that is spent on food.
In 1980 farmers received 31¢.
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AGRICULTURAL AGRICULTURAL TRADETRADE
InIn 20012001Total U.S. Agricultural exports = $53 billionTotal U.S. Agricultural exports = $53 billionTotal U.S. Agricultural imports = $39 billionTotal U.S. Agricultural imports = $39 billion
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MORE THAN FOODMORE THAN FOODEthanol
1.77 billion gals. produced in 2001
655 mil. bu. of corn and 33 mil. bu. of grain sorghum used
61 ethanol plants in operation with 50 new plants scheduled to be on line by 2004
BiodieselFrom Jan 1999 to Sep 2001, more than 100 major vehicle fleets implemented biodiesel programs. i.e.
U.S. Army State of New Jersey Cincinnati city buses Florida Power and
Light
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AGRICULTURAL AGRICULTURAL TERMINOLOGY AND TERMINOLOGY AND
PRODUCTION / PRODUCTION / CASHFLOW CYCLESCASHFLOW CYCLES
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AGRICULTURAL AGRICULTURAL DEFINITIONSDEFINITIONS
Acre - It was in use in England at least as early as the eighth century, and by the end of the ninth century it was generally understood to be the area of a field one furlong (40 rods or 10 chains) long by 4 rods (or 1 chain) wide. Thus an acre is 10 square chains, 160 square rods, 43 560 square feet or 4840 square yards.
Furlong - The word "furlong", from the Old English fuhrlang, means "the length of a furrow"; it represents the distance a team of oxen could plow without needing a rest. A furlong equals 40 rods, which is exactly 10 chains, 220 yards, 660 feet, or 1/8 mile.
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AGRICULTURAL AGRICULTURAL DEFINITIONSDEFINITIONS
Chain - a unit of distance formerly used by surveyors. The traditional British surveyor's chain, also called Gunter's chain because it was introduced by the English mathematician Edmund Gunter (1581-1626) in 1620, is 4 rods long: that's equal to exactly 1/10 furlong, 22 yards, or 66 feet (20.1168 meters).
Rod - a traditional unit of distance equal to 5.5 yards (16 feet 6 inches or exactly 5.0292 meters). The rod and the furlong were the basic distance units used by the Anglo-Saxon residents of England before the Norman
Conquest of 1066.
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AGRICULTURAL AGRICULTURAL DEFINITIONSDEFINITIONS
Bushel - a commercial unit of weight for grains and other bulk commodities. Agricultural commodities such as wheat are traditionally sold by the bushel, but because commodities tend to settle and compact in shipping, disputes over the volume delivered arise easily. To avoid these disputes, traders in a market or a country generally agree on a standard weight for one bushel of the commodity. Often this standard weight is set by law. Although the bill of lading still shows "bushels," it is really the weight rather than the volume that is sold and guaranteed. For example, in the United States a bushel of wheat equals 60 pounds (27.216 kg), a bushel of barley 48 pounds (21.772 kg), a bushel of oats 32 pounds (14.515 kg), and a bushel of rye 56 pounds (25.401 kg).
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AGRICULTURAL AGRICULTURAL DEFINITIONSDEFINITIONS
Hundredweight (cwt) - a traditional unit of weight equal to 1/20 ton. The U.S. hundredweight seems to have been invented by merchants around 1840. To distinguish the two hundredweight units, the British version is often called the long hundredweight (112 lbs.) and the American is called the short hundredweight (100 lbs.)
Barrel (bbl) - a commercial unit of weight, varying with the commodity being measured.
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AVG. BU. WTS. AND AVG. BU. WTS. AND SEEDS / LB.SEEDS / LB.
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HYBRID MATURITYHYBRID MATURITYMost crops mature enough to harvest in 120 to 180 days. This is not an exact figure, because growth rates are based on “heat units”. For example corn will not grow when the temperature is below 50° F and will not mature any faster once temperatures are higher than 86° F. Once they have accumulated enough heat units, then they are considered mature.
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GESTATION PERIODSGESTATION PERIODS
Cow – 285 days Horse – 337 days Sheep – 148 days Goat – 151 days Pig – 113 days
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CASHFLOW CASHFLOW CONSEQUENCESCONSEQUENCES
At best an agricultural producer will only have positive cash flow anywhere from one to three times in a year.
Counselor thinking has to adjust to the differences in the timing of cash flows.
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FINANCIAL MINDSET FINANCIAL MINDSET OF AGRICULTURAL OF AGRICULTURAL
PRODUCERSPRODUCERS
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AGRICULTUREAGRICULTUREdefined todaydefined today
Agriculture has been described as “asset rich and cash poor.” This is an extremely accurate definition. The land has probably been handed down for generations, the equipment costs in the hundreds of thousands of dollars, yet prices have remained relatively static.
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COMPARISONSCOMPARISONS
PRICE OF COTTON
1950 - 40¢ per lb. 1990 - 67¢ per lb.
An increase of 68%.
COST OF EQUIPMENT(Tractor, planter, plow)
1950 – $18,000 1990 – $96,400
An increase of 436%.
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AGRICULTUREAGRICULTUREfinancially definedfinancially defined
Irrational adj. 1.a Not endowed with reason. b. Affected by loss of usual or normal mental clarity. c. Contrary to reason; illogical.
Investor n. 1. A person that commits money or capital in order to gain profit or interest.
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2001-2002 RMA2001-2002 RMACotton and Cash Grains ROECotton and Cash Grains ROE
Cotton Quartiles (SIC # 0131) 59.8 10.5 (11.1)
Cash Grain Quartiles (SIC # 0115) 14.8 3.8 (0.6)
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2001-2002 RMA2001-2002 RMABeef Cattle and Hogs ROEBeef Cattle and Hogs ROE
Beef Cattle Quartiles (SIC # 0212) 16.2 5.3 (2.5)
Hog Quartiles (SIC # 0213) 66.4 27.6 14.2
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COMMODITY PRICINGCOMMODITY PRICINGWhen preparing a FSA guaranteed loan, the Agency provides commodity pricing for calculating income. If current pricing is needed I use two sources:
1. ftp://ftp.fsa.usda.gov/public/ratespub/default.htm
2. http://www.ams.usda.gov/lsg/mncs/ls_amar.htm
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BREAK FOR LUNCHBREAK FOR LUNCH
REMEMBER, IF YOU EAT, YOU ARE INVOLVED WITH
AGRICULTURE!
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BENCHMARK RATIOS BENCHMARK RATIOS AND THEIR AND THEIR
CALCULATIONSCALCULATIONS
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Farm Financial Farm Financial Standards Task ForceStandards Task Force
Identify certain ratios common to all areas of the country
Identify standard methods of calculating these ratios
Draw up standardized farm financial statement guidelines that may be used by all farm lenders
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LIQUIDITY RATIOSLIQUIDITY RATIOS
MEASURES ABILITY TO TURN ASSETS INTO CASH:
Current RatioWorking Capital
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CURRENT RATIOCURRENT RATIO
Current Assets
Current Liabilities
>150% is strong <100% is risky
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WORKING CAPITALWORKING CAPITAL
Current Assets (–) Current Liabilities
Working capital is an absolute number and indicates how much flexibility the
producer has in managing the business.
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LEVERAGE RATIOSLEVERAGE RATIOS
MEASURES THE AMOUNT OF OUTSTANDING DEBT:
Debt to Asset
Debt to Equity
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DEBT TO ASSETDEBT TO ASSET
Total DebtTotal Assets
<30% is very strong >70% represents high risk
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DEBT TO EQUITYDEBT TO EQUITY
Total Debt
Total Equity
<42% is strong financial position
>230% is high risk
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PROFITABILITY PROFITABILITY RATIOSRATIOS
MEASURES EFFECTIVENESS IN TURNING SALES INTO PROFIT:
Operating Profit Margin
Return on Assets
Return on Equity
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Net farm income from operations (+) interest expense (–) operator management
fee () gross farm revenue
>25% is profitable<10% is high risk
OPERATING PROFIT OPERATING PROFIT MARGINMARGIN
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Net farm income from operations(+) interest expense(–) operator management fee() average total farm assets
>5% is profitable <1% is high risk
RETURN ON ASSETSRETURN ON ASSETS(mostly owned)(mostly owned)
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RETURN ON ASSETSRETURN ON ASSETS(mostly leased)(mostly leased)
Net farm income from operations (+) interest expense (–) operator management fee () average total farm assets
>12% is profitable <3% is high risk
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RETURN ON EQUITYRETURN ON EQUITY
Net farm income from operations
(–) operator management fee
() average total farm equity
ROE is a dangerous ratio: it can be artificially inflated by low equity!
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EFFICIENCY RATIOSEFFICIENCY RATIOS
MEASURES PRODUCTIVITY OF YOUR BUSINESS ASSETS:
Operating Expense ratioInterest Expense ratioDepreciation Expense
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OPERATING EXPENSE OPERATING EXPENSE RATIORATIO
(mostly owned)(mostly owned)
Total farm expense (+) interest expense (+) depreciation () gross farm revenues
<65% is very efficient >80% is high risk
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OPERATING EXPENSE OPERATING EXPENSE RATIORATIO
(mostly leased) (mostly leased)
Total farm expense
(+) interest expense
(+) depreciation
() gross farm revenues
<75% is very efficient >85% is high risk
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INTEREST EXPENSE INTEREST EXPENSE RATIORATIO
Interest expenseGross revenues
How important is borrowed capital?
<12% is a strong position >25% is very risky
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DEPRECIATION DEPRECIATION EXPENSE RATIOEXPENSE RATIO
Depreciation expense
Gross revenues
If capital expense and term debt margin is greater than depreciation, then producer
can replace capital assets. If reversed, then could be living off of depreciation.
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REPAYMENT REPAYMENT ANALYSISANALYSIS
MEASURES ABILITY TO MEET
REPAYMENT OBLIGATIONS
Term Debt & Lease Coverage Ratio
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TERM DEBT & LEASE TERM DEBT & LEASE COVERAGE RATIOCOVERAGE RATIO
[ (Net farm income from operations
(+) gross non-farm revenue
(+) depreciation expense
(+) interest on term debt & capital leases)
(–) family living & income tax expense ]() scheduled principal & interest
and capital lease payments
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COMMON FSA FORMSCOMMON FSA FORMS
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CASE STUDIESCASE STUDIES
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TREND & INDUSTRY TREND & INDUSTRY ANALYSISANALYSIS
display 3+ years financial history
compare to industry standards
use common-sized financial statements
perform ratio analysis against industry averages
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IOU FARM & RANCHIOU FARM & RANCH
Robert E. Lee dba IOU Farm & Ranch is preparing for next year’s operating loan
FSA declared 1998 as a disaster year for the local area
Banker wants complete borrower plan for next year’s operation
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PREPARING FOR THE PREPARING FOR THE BANKBANK
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CHARACTERISTICS OF CHARACTERISTICS OF A AG LENDERA AG LENDER
1. Show understanding of agriculture as it exists today
2. Experience in ag credit and commitment to agriculture
3. Reputation for honesty and integrity
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CHARACTERISTICS OF CHARACTERISTICS OF A AG LENDERA AG LENDER
4. Willing to discuss policies and terms and take prompt action to credit requests
5. Capacity to meet anticipated credit needs
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CHARACTERISTICS OF CHARACTERISTICS OF A AG BORROWERA AG BORROWER
Arrange credit in advance
Allow lender to review plans and make suggestions
Inform the lender of problems and changes
Maintain a high level of integrity
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CAUSES OF PROBLEM CAUSES OF PROBLEM LOANSLOANS
Non-financial FactorsNon-financial FactorsConditions and Behaviors
– Poor production & marketing practice
– Investment purchases based on “paint fever”
– Family living costs exceeding 20% of gross farm revenue
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CAUSES OF PROBLEM CAUSES OF PROBLEM LOANSLOANS
Non-financial Factors Non-financial Factors (cont’d)(cont’d)
Conditions and Behaviors (cont’d)
– Increased health care costs
– Alcohol and/or drug abuse
– Marital problems and divorce
– Fraud and poor ethics
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Stage 1:
85% doing
15% managing
Stage 2:
66% doing
34% managing
Stage 3:
34% doing
66 % managing
Stage 4:
15% doing
85% managing
CAUSES OF PROBLEM CAUSES OF PROBLEM LOANSLOANS
Non-financial Factors Non-financial Factors (cont’d)(cont’d)
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CAUSES OF PROBLEM CAUSES OF PROBLEM LOANSLOANS
Non-financial Factors Non-financial Factors (cont’d)(cont’d)Problems created by the Lender.
– Debt Structure: Nontraditional lender offers low rates but short terms
– Financing assets beyond useful life
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Problems created by the Lender (cont’d)
– Failure to judge repayment capacity (5-5-3)
– Misinterpreting financial information.
– Change in loan officers, shift in policies, buyouts/mergers
– Communications gap
CAUSES OF PROBLEM CAUSES OF PROBLEM LOANSLOANS
Non-financial Factors Non-financial Factors (cont’d)(cont’d)
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Outside Forces
– Weather
– Price change received for products
– Interest rate risk
– Decline in asset values
– Loss of assets due to natural disaster
CAUSES OF PROBLEM CAUSES OF PROBLEM LOANSLOANS
Non-financial Factors Non-financial Factors (cont’d)(cont’d)
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Downward trend in ROA or ROE
Living off of depreciation
A/P buildup, debt to family, credit cards
CAUSES OF PROBLEM CAUSES OF PROBLEM LOANSLOANS
FFinancial Factorsinancial Factors
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Failure to pay taxes
Cancellation of insurance
Operating expense ratio is >80% with Debt/Asset ratio over 50%
CAUSES OF PROBLEM CAUSES OF PROBLEM LOANSLOANS
FFinancial Factors inancial Factors (cont’d)(cont’d)
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Debt Coverage Ratio
declining or <1 for multiple
years
Financing operating loan as
long-term debt
CAUSES OF PROBLEM CAUSES OF PROBLEM LOANSLOANS
FFinancial Factors inancial Factors (cont’d)(cont’d)
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Interest expense more than
25% of revenues
Split LOC from many sources
(>5)
CAUSES OF PROBLEM CAUSES OF PROBLEM LOANSLOANS
FFinancial Factors inancial Factors (cont’d)(cont’d)
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Excessive family living
expense
Too much leverage:
D/A >70% D/E >230%
CAUSES OF PROBLEM CAUSES OF PROBLEM LOANSLOANS
FFinancial Factors inancial Factors (cont’d)(cont’d)
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7 POSSIBLE OPTIONS OF A 7 POSSIBLE OPTIONS OF A WORKOUTWORKOUT
1. Examine ways to cut both fixed and variable costs: concentrate on 4 or 5 largest costs
2. Sale of capital assets: assets must have a market and are not critical to daily operations
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3. Use outside incomes to improve the cash flow of the business (over expenses)
4. Reduce family living withdrawals (Yeah, right!)
5. Capital infusion from outside sources (usually not workable)
7 POSSIBLE OPTIONS OF A 7 POSSIBLE OPTIONS OF A WORKOUTWORKOUT
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5. Lender options– Oral forbearance– Principal deferment– Principal and interest deferment– Complete re-amortization
7 POSSIBLE OPTIONS OF A 7 POSSIBLE OPTIONS OF A WORKOUTWORKOUT
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6. Lender Options (cont’d)– Debt restructuring; requires high
equity (usually 70+%)– Voluntary liquidation– Voluntary conveyance– Foreclosure
7. Bankruptcy
7 POSSIBLE OPTIONS OF A 7 POSSIBLE OPTIONS OF A WORKOUTWORKOUT
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AG FINANCIAL AG FINANCIAL STATEMENTSSTATEMENTS
Father to his adult offspring: “Someday I will let you see the books,” referring to the financial condition of the farm. The father is 71. The “child” is 42.
You wonder why some farms fail financially!