In times of positive cash flow, producers have more financing freedom. Though it carries higher initial cash outlays, securing short-term financing can reduce term debt quicker and at a lower overall cost.
But when times are financially tight, and cash flow more restrictive, short-term financing – or outright cash purchases – can put a larger, more immediate financial strain on an operation. Sure, you’re paying less interest in the long run, but larger short-term financing payments can be enough to sink some operations. This is especially true when facing a continually challenging marketplace, as producers are today.
Restructuring debt is one way to make cash more readily available in the short term. Going through the process carries risk through higher longer-term costs, especially when financing things like machinery. However, it is a necessary step in terms of helping stabilize operating capital and sustaining production.
Restructuring debt essentially spreads financing costs out over a longer period of time, lowering payments as terms are stretched. It also lowers the per-bushel breakeven price. Corn projections earlier this summer had the breakeven price at around $4/bushel. The soybean breakeven price was around $10/bushel. With new-crop futures and cash prices hovering in a range around those prices, raising a crop for less than these breakeven points can seem unattainable.
This is where debt restructuring can help.
Changing a five-year financing plan to 10 years, for example, will lower each payment, freeing up cash in the short term and lowering the breakeven price. If the overall cost of production was near the breakeven under shorter financing terms, lengthening those terms should lower short-term operating costs and enable producers to lower their breakeven price.
That’s the primary benefit of this strategy. But, it has drawbacks.
One disadvantage is that extending financing increases overall financing costs in the long term. Ensuring an operation’s equity is strong enough to sustain that extended financing is critical to the successful execution of this strategy.
It’s important not to “kick the can down the road,” especially on assets that may not have a long usable life. If restructuring financing terms for a tractor purchase, for instance, it would be important to ensure the bank was not extending the loan beyond the operating life of the machine. Making payments on equipment that is no longer a functional asset swells debt levels and does not set a farm operation up for financial stability.
Another potential drawback to extending financing terms ties to interest rates. Right now, rates are going only one direction, and the upturn is expected to last through 2018 and beyond. Producers hoping to free up cash today must be sure they can afford to pay higher interest rates throughout the life of their newly restructured loan.
So, what should I do?
If you’re on the fence about restructuring farm debt to free up cash, start by looking at the expense side of your balance sheet, namely your fixed costs. If extending financing terms will make it difficult to cover those costs over a longer period of time, restructuring debt may not be the best strategy for you.
Restructuring debt is a strategy that can be beneficial in some situations but can also extend an operation’s financial risk. It’s a decision that should be made alongside a trusted financial partner who can help you examine all of the variables and determine whether it can work for you.
This is a guest post from our friends at Bank Iowa.
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