Cash flow crunch:

This information can be derived from the existing financial information and involves determining your variable costs and fixed costs for each crop or commodity. Some variable costs are directly related to each crop or commodity and include seed costs, fertilizer, and spray costs among others.

Other variable costs may also be indirectly related to each crop or commodity such as labor and utility costs. It should be noted that variable costs are subject to increases or decreases in relation to production.

Fixed costs may include costs like interest and property taxes. These are typically added in to figure out the total costs and calculate them on a per acre basis.

Very often, these costs can be calculated based on a formula that can become complex. In general terms, we look at the original cost, the useful life, and the residual value of the assets. These costs are often related to the amortization rates set by the producer, and they also include lease costs for equipment.

Start by itemizing your crop or commodity. For instance, when taking crops into account, we would take the crop type and multiply it by the number of acres planted and the expected price per acre.

The resulting amount will then be reduced by the per acre costs of production and equipment costs. This resulting number will be the per acre contribution margin for each crop or commodity.

We can then do a pro-forma projection of the financial contribution that the purchase will generate for the operation.

Finally, you'll need to know what your existing bank covenants are and determine if these covenants will change with the new financing.

With all these answers, the financial position of the entity after the acquisition can be estimated, including the calculation of the projected bank covenant ratios. With these projections in hand, a farmer will have a good idea if they will be able to sustain financing and if the purchase will increase the farm's overall profitability.

Earnings before interest, taxes, depreciation, and amortization (EBITDA) are often important calculations here. The calculated new EBITDA for the farm will be what's available for debt coverage (interest and principal payments). This resulting debt coverage ratio will also be imperative to lenders.

With that in mind, farmers should not just aim at meeting the debt coverage requirement, but also set goals to exceed that bank requirement and increase the EBITDA to obtain maximum profitability. This could, in turn, provide a case for better financing terms and rates, making it very important considering the current inflationary market and rising interest rates.