Many in agriculture will develop creative strategies at year-end to minimize income taxes or increase the actual loss. This is great for deferring taxes, but it can send a bad message to your ag lender.
A veterinarian friend of mind and former student was denied a loan from a bank because this practice never generated a profit. This was a result of investment and prepaying inventory strategies, which minimized the tax bite. While he eventually obtained the loan, it was at a higher interest rate. The lesson was a costly one, in that lenders do look for signs of profit in your business.
If you would like to benchmark yourself, the top 25% of commercial businesses on farm record keeping systems typically generate a return on assets (ROA) of 10% or more. ROA is calculated by taking the net income, plus interest paid, divided by total assets. For example, a farm with $50,000 profit, $50,000 in interest paid with $1,000,000 in assets would generate a return of 10%.
You are more likely to be denied for credit when the return is in the 1-2% or negative range. Another sign that ag lenders look for is a trend either up or down. They will also consider where the industry is in the cycle.
Editor’s note: Dave Kohl, The Corn And Soybean Digest Trends Editor, is an ag economist specializing in business management and ag finance. He recently retired from Virginia Tech, but continues to conduct applied research and travel extensively in the U.S. and Canada, teaching ag and banking seminars and speaking to producer and agribusiness groups. He can be reached at sullylab@vt.edu.