Last week I had the pleasure of spending two quality days with Greenstone Farm Credit Services in Michigan and Badgerland Farm Credit Services in Wisconsin. By the end of our two-day tax return analysis training, one of the lenders said:
“I never thought I’d say this about tax returns, but I’ll spend two days with you learning about tax return analysis any time!”
Replacement of Assets: An Ag Lenders approach
Like their colleagues at Northwest Farm Credit Services (where I have done this ag focused training for 13 years and counting), the ag lenders pay a lot of attention to whether a farming operation is replacing the assets critical to their success on a reasonable basis.
Here is one way to do it:
- First enter into your system the depreciation per the tax return as a rough estimate of how much has been ‘used up’. The term for this is ‘Use Cost’.
- Next adjust that number.
- This may be to depreciation per books and records which is not distorted by Section 179 first-year write-off, for example.
- Or you may have a formula that makes sense for the type of operation…dairy, cattle, crops or orchards.
- Another factor is the stage the operation is in. Is it still ramping up? Is it established?
- Finally, compare the adjusted ‘Use Cost’ to the capital purchases. If the purchase is financed, you may compare to the down payment plus principal payments on capital purchase loans. This helps spot if a farming operation has some catch-up to do in order to stay on course.
Understanding where they are in replacement of capital assets, ahead or behind, is an important factor in making a good loan decision on whatever the request is now.
Business lending application
A business lender can review the equipment list. Some tax software includes this even though not required. But sometimes you’ll need to get it from borrower records.
- Does the equipment list make sense for what I think the business does?
- Are there major changes that might indicate a change in focus?
- Have they replaced equipment on a similar pace to their historical usage?
- If not, why not?
- Do they need to play catch-up?
- How does that impact the loan decision I am making now?
How about you?
How do you take into account capital replacement needs? Do you have any formulas or expectations for different kinds of businesses?