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financial analysis and decision making pdf
Buying farmland is the largest investment many farmers will make in their careers. For this reason a careful analysis of the decision is critical to long-term financial security. This information file will discuss the financial analysis of a farmland purchase.
Farmland is a unique asset that, if managed correctly, has an infinite productive life. However, purchasing farmland represents a large, one-time expenditure. The challenge that a would-be purchaser faces is how to access enough capital before the expected revenues are received. Two general types of capital can be utilized:. Debt : funds that the purchaser borrows from other entities or individuals.
Some purchases of farmland are made with percent equity capital. The buyer may have to pull together funds from several different accounts or investments, or even sell some other assets. After the purchase is made, however, no further payments are needed. The majority of farmland purchases involve a combination of equity and debt capital.
Some lenders require a fixed percent of the purchase price as a down payment, while others specify a minimum dollar value that they will loan. Three factors determine the size of the payments a borrower must make to repay a land loan. The most important is the amount borrowed, or the principal. Second is the term , or the length of time over which the loan must be repaid. The third is the interest rate , or the cost of borrowing capital. Together they make up the amortization of the loan.
Most long-term farm loans are amortized as a series of equal payments. At the beginning, each payment is mostly interest plus a small amount of principal. The amount of interest due is always equal to the outstanding principal x the annual interest rate x the fraction of a year since the loan was received or the most recent payment was made. Table 1 at the end of this file contains a series of amortization factors.
For a given number of repayment periods and the interest rate per repayment period, the corresponding amortization factor from the table is multiplied by the number of dollars originally borrowed to find the total payment due each period.
Some loans are amortized with a balloon payment , that is, a large portion of the principal is due at the end of the term. The purpose is to reduce the size of the payments before the balloon payment comes due. At the end of the term the borrower may have saved enough money to make the balloon payment, the remaining principal owed may be re-amortized over another term by the same lender, or the borrower may obtain funds from another lender to make the balloon payment.
This last choice is a common practice when the balloon payment is part of a seller-financed installment contract. The amortization factor is 0. There are two approaches to estimating the net revenue from a tract of farmland that will be available for servicing debt:.
Net revenue to an owner- operator of farmland is the sum of the expected gross revenue from all the products that can be produced on it, minus the cash variable costs of producing them, minus the cash costs that occur from owning the land. Gross revenue is the number of acres of each crop that will be grown on the land in a reasonable long-term crop rotation, multiplied by the expected yield of each crop, multiplied by its expected selling price.
Expected yields and prices should be based on averages obtained on similar land in recent years or long-term projections, not on current values. There may be other sources of income tied to the land beside sales of crops. These include sales of secondary products such as straw or corn stover, payments for being enrolled in Conservation Reserve CRP or Wetland Reserve WRP Programs, payments from other government programs, rental of buildings or dwellings, royalties received for mineral production, and payments for easements for wind turbines, pipe lines or other uses.
Production costs include standard inputs such as seed, fertilizer and pesticides, machinery and labor costs, crop insurance premiums, miscellaneous costs such as soil testing and crop scouting, and marketing expenses.
Short-term interest costs on funds tied up in crop expenses should also be included if operating funds are borrowed, but not if equity capital is utilized to pay them.
Average farm custom rates can be substituted for machinery and labor costs if those costs are not well known on a per acre basis, or if the land will be farmed under a custom farming agreement. However, if a certain amount must be withdrawn to meet nonfarm expenses such as family living and income taxes, this value should be included. Certain costs that come about just by owning the land should also be included.
These include real estate taxes, insurance, and upkeep of terraces, tile lines, fences, and buildings. Depreciation costs should not be included, however, as they are not cash expenditures. The expected net income from the land available for debt servicing is the sum of the expected gross revenue per acre minus variable costs for each crop, multiplied by the expected acres of that crop, plus any other sources of income, minus cash land ownership costs and any other cash outlays.
Keep in mind that not all acres in a tract of land will be suitable for producing crops, that is, estimates of revenue and expenditures should be based on tillable acres and pasture , only, even though a buyer will have to pay for all the acres. Non-operating Owner. Sometimes farmland will be purchased as investment and rented to a ten- ant operator.
The simplest way to estimate revenue from renting land is to look at current cash rental rates for farms of similar quality in the same geographic area. Keep in mind that if current price levels are above or below long-term averages, current rental rates may have to be adjusted upward or downward to reflect long-run prospects. The estimated rental rates per bushel or per CSR2 index value can be used to adjust county average rents to a reasonable value for a specific tract. Keep in mind that rent is typically received only for the tillable acres or acres in pasture.
Subtract the same ownership costs as discussed before from the estimated gross rent. If a professional farm manager will be employed to manage the property, the fee that will be charged for this service should be deducted, as well. Some landowners prefer to rent their land under a crop-share lease, or hire a custom operator to perform machinery and labor operations.
In those cases the net revenue accruing to the landowner can be estimated by including only the share of income received by the owner and only the share of production costs paid by the owner. Table 2 shows an example of how a prospective buyer who intends to farm a tract of land would estimate its net cash flow. The tract has acres, of which are tillable, and the expected rotation is half corn, half soybeans. No other sources of revenue are anticipated.
The deficit would have to be made up with cash generated from the existing farming operation or off-farm income. The financial feasibility of purchasing farmland depends not only on the price paid for the land, but on how much of the purchase price must be borrowed, and at what term and interest rate.
Most of these factors depend on the financial situation of the specific borrower rather than the characteristics of the land itself, and do not affect the economic value of the land. Finding the right combination of purchase price, financing and tenure arrangement makes investing in farmland an interesting challenge. William Edwards, retired economist. Written November, File C Farmland purchase analysis. William Edwards retired extension economist View more from this author.
The Role of Finance in the Strategic-Planning and Decision-Making Process
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Buying farmland is the largest investment many farmers will make in their careers. For this reason a careful analysis of the decision is critical to long-term financial security. This information file will discuss the financial analysis of a farmland purchase. Farmland is a unique asset that, if managed correctly, has an infinite productive life.
Financial Analysis on the Company Performance in Malaysia with Multi-Criteria Decision Making Model
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