When a farm credit lender is evaluating a farmer, what data points matter the most?
Farm credit lenders evaluate farmers holistically. Cash flow, farm assets, and credit history are often data points in the larger picture (some lenders call this picture the “5 C’s of Farm Credit“). With so many factors in play, what information is the most important?
Welcome back to Part II of this series (Part I here)! Today, we’re going to explore the current ratio, the second measure of risk that lenders check when assessing your loan application. The current ratio is your farm’s current assets (including cash and checking, crops grown, accounts receivable, etc) divided by your farm’s liabilities (including accounts payable and farm debt).
This ratio is key because it measures the percent of your current assets, if they were liquidated today, that could cover your farm’s outstanding liabilities (if your current ratio is 2, it means you have $2 of assets to cover every $1 of liabilities). In short, the current ratio is a way to quickly gauge the farm’s liquidity. Farm liquidity is the farm business’s ability to cover upcoming bills and other outstanding debts through cash-based assets or assets that can be converted into cash. It’s an important measure of risk for lenders because it helps them understand the farm’s ability to pay back current and future debt given its current asset base.
So what’s a “good” current ratio? Ideally, you want your current ratio to be above 1.5, indicating a healthy level of liquidity. If it’s between 1.0-1.5, your farm is still liquid, but it’s more vulnerable to economic shocks. A current ratio below 1.0 indicates a very low level of liquidity.
There are many ways to increase your liquidity, but one of the most straightforward is increasing your farm’s income. Building your income can allow you to access additional farm credit working capital to invest in and expand your farm in the years ahead. We’ll get into this more in coming posts, but as a sneak preview, here’s a quick guide for 3 steps that can boost farm profitability. Stay tuned for more data points in Part III coming this week.