UNDERSTANDING how a bank calculates your interest rate provides an opportunity to reduce this cost.
All businesses are being faced with tighter margins. Farmers are no different apart from having a few other variables to contend with. Part of the equation for a profitable business is to reduce or control costs while maintaining or increasing income.
If you are a borrower one of your main expenses can be the cost of funds or interest and fees. You may think you have no control over what interest rate is being charged, however this is not entirely correct.
The cost of funds or interest rate is calculated based on the bank's costs of funds plus a client margin which is calculated by the bank based on the client risk profile. The client risk profile will determine the risk margin, the loan term and other requirements and conditions of the loan agreement.
The credit risk profile is determined by the bank assessing your business from two main angles. Firstly there is the financial side of the equation. This will typically include assessing the historical financial data, projected cashflow forecasts, current net equity position, account conduct and credit history.
The second criteria assesses such areas as how the enterprise is structured, management experience, trading history, succession planning, estate planning, economic environment; risk management including price and production risk management, diversification and exit strategies. That is, does the farming operation have a plan?
Implementation of better management and planning practices in your farming enterprise will not only help to reduce loan funding costs but provide up-to-date information for decision making. So, there is much to be gained by working through this process.
The first step is to become better financially organised.
This includes completing a farm business review to obtain a better understanding of how your farming enterprise is currently positioned.
The next step involves taking the information from the farm review to complete a list of priorities that need to be actioned to improve your business.
The third step is implementation and review. For example, this could include the preparation of quarterly financial management reports with comparison to budget, developing a succession plan etc. Be proactive and put this process in place to not only assist with better management and decision making but to also assist with reducing the cost of borrowing.
Chris Mulcahy is a director of Mulcahy and Co.