I. Definition - Financial Risk

The additional risk resulting from debt. Increasing leverage increases the chance of losing equity and/or being unable to meet debt servicing commitments.

A. Operational risk - internal
B. Strategic risk - external

II. Information

A. Good decisions require adequate, accurate and timely information
1. The GIGO principle
B. Enterprise or cost/profit center records
C. The "5 percent" rule

III. Financial Statement Analysis

A. Criteria
1. Liquidity
2. Solvency
3. Profitability
4. Financial efficiency
5. Repayment capacity
B. Analysis techniques and tools
1. Financial statement
a. Balance sheet
b. Income statement
c. Statement of cash flows and cash flow budgets
d. Statement of change in owner equity
e. Trends
f. Cost versus market value
1. Earned versus valuation equity
g. Asset versus debt structure
1. Matching
h. Cash versus accrual
1. Accuracy - Lins study
2. Cash conversion cycle
C. Pro Forma Analysis
1. What if scenarios
2. Commodity and weather cycles
a. Repayment capacity margin
b. Sustainability
3. Breakeven
a. Cash flow
b. Profitability
D. Monitoring and Control
1. Projected versus actual
a. Cash flow
1. Frequently unrealistic and unsupported
2. Budgeting error study
3. Family living as well as business
b. Variance analysis
1. Timing - cancer analogy
2. Causes versus symptoms
c. Adjustments to plans and operations
E. Ratio Analysis
1. Standards
a. Industry
b. Firm
2. Multiple perspectives
a. Trend (slope)
b. Historical variability
c. Projected versus historical average
3. Sensitivity analysis
4. Interrelationships
a. Differences between types of businesses
1. Jewelry store versus grocery store
b. DuPont model

IV. Credit

A. Being Prepared to Borrow as a Commercial Business
1. How much money are you going to need?
2. What is the money going to be used for?
3. How will the loan affect your financial position?
4. How will the loan be secured?
5. How will the loan be repaid?
6. When will the money be needed and when will it be repaid?
7. Are projections reasonable and supported by documented historical information?
8. How will alternative possible outcomes affect repayment ability?
9. How will the loan be repaid if the first repayment plan fails?
10. How much can the borrower lose and still maintain a viable operation?
11. What risk management measures have been or are to be implemented?
12. What are the trends in the business s key financial indicators?
a. If the trends are adverse, what are the specific plans for turning things around?
B. Other Considerations
1. Lease versus purchase alternatives
a. Fixed rates
b. Down payment
c. Term versus asset life
d. Landlords
e. Tax issues
2. Nontraditional lenders
3. Farm Service Agency loan guarantees
a. Ability to reamortize debt in event of adversity
b. Interest buy-down provision
c. Regulator criticism factor
d. Increased likelihood of lender forbearance
4. Interest rate risk
a. Adjustable rate caps
b. Prepayment penalties
c. Hedging
d. Yield curve slope and potential shifts
5. Term debt amortization period versus repayment capacity margin
a. Cycles and trends
b. Macro variables
6. Loan agreement covenants
a. Trigger points
b. Management restrictions
c. Cost of compliance
7. Insurance coverage
a. Investment versus insurance
b. Type, coverage and cost

V. Real Estate Lease Considerations

A. Length
B. Cash Versus Share
C. Combination Leases
D. Bonus and Disaster Clauses
E. Contract Provisions

VI. Production and Marketing Contracts

A. Will Production Costs be Higher?
1. Production practices
2. Specialized inputs
B. What is the potential for lower yields?
C. Is the contract on an acreage or quantity basis?
D. What are the quality discounts?
1. What happens if standards are not met?
2. Is the determination at the discretion of the buyer?
E. If investment in specialized equipment is involved, does the contract length match?
F. How financially sound and ethical is the contracting entity?
G. What is open market prices drop or there is excess production of the contracted commodity?
H. What are the breach of contract clauses?
1. How will production shortfalls be treated?
I. Is there a passed acres clause and how is it handled?
J. Who owns the commodity?
K. When will payment be made?
L. How will disputes be resolved?
M. What are the harvest timing window?
1. Which state s laws apply?
N. Does the producer maintain the kind of records it will take to prove compliance with contract provisions?
O. What is the basis for termination or renewal of the contract?
P. Can the contract be assigned and who has to approve?
Q. Are land lease terms subject to change?

VIII. External Investor and Multiple Owner Considerations

A. Alternative investment instruments
1. Common stock
a. Voting
b. Non-voting
2. Preferred stock
a. Cumulative
b. Convertible
c. Participating
d. Combinations of the above
3. Convertible debt
4. Straight debt with warrants (options)
B. Buy-sell agreements
1. Reasons for
a. Protection of minority owners
b. Succession planning
c. Reorganization planning
2. Types of plans
a. Cross-purchase
b. Entity
c. Combination
3. Provisions
a. Liquidation discount for divorce or premature retirement
b. Antidilution provisions
c. Right of first refusal
d. Take along rights
e. Valuation
f. Installment purchase
g. Management salary/bonus restrictions
h. Arbitration clause
4. Funded
a. Life insurance
b. First-to-die