My friend and fellow financial geek Paul Dietmann says, debt is like a chainsaw. With a chainsaw, you can cut a lot of firewood in a hurry – increasing your capacity to keep your house warm over the winter at a reduced cost.
Or you can cut your leg off.
Like any tools, it’s all about how you use it. Yes, it has risks. But it also has rewards.
Good debt serves a defined purpose to create long-term outcomes. It includes a plan to service the debt – not just a gut feeling that you’ll be able to do it. And good debt creates value for your business.
Good debt – especially long-term debt – should increase the productive capacity of your farm.
Good debt provides a return on investment commensurate with the cash flow required to service it. If you’re borrowing money for your business, the borrowing should create additional cash flow in line with the payments that are due. This is why an operating loan or crop note usually doesn’t require monthly servicing of principal –it takes time for those tomatoes to grow and yield a return on your investment so that you can pay it back.
The payback terms of good debt matches the time it will take to achieve your returns. Don’t finance capital investments with short-term debt, and don’t shorten the term of your debt on your loan documents unnecessarily. By all means, pay loans back faster than the schedule laid out in your loan documents – but you want to be the one providing the discipline to pay down debt quickly, rather than asking the bank to do it. After all, you’re likely to be a lot more flexible if something goes wrong, or if another opportunity presents itself.
The balance on good debt falls faster than the value of the item it was used to finance. When you borrow money to buy a tractor, that tractor will probably be worth less than what you borrow on it the moment you drive it off the lot (or, if you borrowed money to buy a two-wheeled tractor, the moment it’s delivered to your door). If you’ve made a smart investment, the tractor will retain enough value that, pretty soon, it’s worth more than you owe on it – that way, by the time you pay off your loan, you’ve got an asset that has contributed to increased equity on your balance sheet.
Remember: debt doesn’t just take the form of cash borrowing from banks and relatives. When you sell CSA shares, that’s a kind of debt: you’ve borrowed your customers’ money with an expectation that you are going to provide them with vegetables. Too often, I see farmers move CSA sales from winter and spring into the fall to cover cash shortfalls, which creates an unhealthy spiral because they’re bringing cash flow that they’ll need next year into the present – it’s the equivalent of sticking your finger in a hole in the dike. It may be a good way to plug a leak for the moment, but it isn’t a very good long-term strategy.
Likewise, when you pre-sell farmers market vegetables, you’re taking in cash now instead of taking in cash later. Since most pre-sale arrangements come with a discount, farmers who do this run the risk of borrowing from the future at a rate much higher than what would be charged by the bank for an operating loan.
Alternatives to debt also have risks and rewards. By refusing to borrow money to make smart investments, you might miss out on opportunities to grow your business, or enhance its sustainability. Forgoing good tools and the right facilities because of an aversion to debt can be the equivalent of cutting your firewood by hand – a noble undertaking, but one that might result in far more work for the same results.
Or you can cut your leg off.
Like any tools, it’s all about how you use it. Yes, it has risks. But it also has rewards.
Good debt serves a defined purpose to create long-term outcomes. It includes a plan to service the debt – not just a gut feeling that you’ll be able to do it. And good debt creates value for your business.
Good debt – especially long-term debt – should increase the productive capacity of your farm.
Good debt provides a return on investment commensurate with the cash flow required to service it. If you’re borrowing money for your business, the borrowing should create additional cash flow in line with the payments that are due. This is why an operating loan or crop note usually doesn’t require monthly servicing of principal –it takes time for those tomatoes to grow and yield a return on your investment so that you can pay it back.
The payback terms of good debt matches the time it will take to achieve your returns. Don’t finance capital investments with short-term debt, and don’t shorten the term of your debt on your loan documents unnecessarily. By all means, pay loans back faster than the schedule laid out in your loan documents – but you want to be the one providing the discipline to pay down debt quickly, rather than asking the bank to do it. After all, you’re likely to be a lot more flexible if something goes wrong, or if another opportunity presents itself.
The balance on good debt falls faster than the value of the item it was used to finance. When you borrow money to buy a tractor, that tractor will probably be worth less than what you borrow on it the moment you drive it off the lot (or, if you borrowed money to buy a two-wheeled tractor, the moment it’s delivered to your door). If you’ve made a smart investment, the tractor will retain enough value that, pretty soon, it’s worth more than you owe on it – that way, by the time you pay off your loan, you’ve got an asset that has contributed to increased equity on your balance sheet.
Remember: debt doesn’t just take the form of cash borrowing from banks and relatives. When you sell CSA shares, that’s a kind of debt: you’ve borrowed your customers’ money with an expectation that you are going to provide them with vegetables. Too often, I see farmers move CSA sales from winter and spring into the fall to cover cash shortfalls, which creates an unhealthy spiral because they’re bringing cash flow that they’ll need next year into the present – it’s the equivalent of sticking your finger in a hole in the dike. It may be a good way to plug a leak for the moment, but it isn’t a very good long-term strategy.
Likewise, when you pre-sell farmers market vegetables, you’re taking in cash now instead of taking in cash later. Since most pre-sale arrangements come with a discount, farmers who do this run the risk of borrowing from the future at a rate much higher than what would be charged by the bank for an operating loan.
Alternatives to debt also have risks and rewards. By refusing to borrow money to make smart investments, you might miss out on opportunities to grow your business, or enhance its sustainability. Forgoing good tools and the right facilities because of an aversion to debt can be the equivalent of cutting your firewood by hand – a noble undertaking, but one that might result in far more work for the same results.
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