The following information on small farm finance comes from Five Acres and Independence by M. G. Kains. Five Acres and Independence is also available to purchase in print.
Credit is a powerful agency for good for whoever knows how to use it; dangerous for those who do not. Like land, capital is a factor which requires use—investment. Hence its extensive employment in farming has developed because machinery demands it. Though in the past little money was needed to start farming, today the cost of good land and machinery require far greater sums.
Capital, as money, originates in only one way—consumption of less than produced. You may spend a dollar for amusement or for a tool. In the first case you may satisfy your desires—”get the worth of your money”; in the second you become an investor, a capitalist, to the extent that you use the tool to create more dollars. If you do not have a dollar your only chance to become such an investor or capitalist is to borrow the tool or the money with which to buy it. No matter which of these plans you adopt the lender of either must place confidence in you—give you credit.
Capital for farm equipment may be secured in only two ways; by consuming less than one produces so as to accumulate it, or borrowing it. The disadvantage of the former is that one is handicapped until the necessary equipment is accumulated; the advantage of the latter is that this delay can be eliminated and the tools used at once to pay for themselves. This is the only advantage credit has in any business. For those who know how to use it, it is a powerful aid.
However, credit is not to be invoked without due calculation. Machines wear out, seasons are unfavorable, prices fall, unforeseen events occur, but payment time is inexorable. It comes with fatal certainty. Debts, unless paid, may bankrupt the borrower just as surely.
Borrowing money for production is no more dishonorable than borrowing tools for the same purpose. What has stigmatized it as such in the past is borrowing to pay the cost of living, still more of “living high.” To borrow for production shows business enterprise as honorable in its degree as borrowing to build a rail-way, found a factory, or buy goods to stock a department store.
In the past usury or interest was condemned because the money borrowed was too often used for non-productive purposes. Modern thinkers and teachers favor interest obligations when the borrowing is for production; the only insistence is that the legal rate be fixed by the state. Except where the rate is exorbitant interest gives little trouble; it is principal that does. When a man borrows $100 at 6% for a year, the debt to pay when due is $106; when he can borrow from another source at 5% the debt is $105, a difference of $1. This is not merely $1, but just that much capital to be either saved for later use or ignored and wasted. Good business saves just such and even smaller items. However, the point here is not the difference of $1 but the $100 original capital which is identical in both cases.
The only safe way to use the borrowed money is to establish means of payment beforehand. For instance, if the $100 at 6% is invested in fertilizer which increases crop yields of $125, not only the interest but the principal could be paid out of earnings and the difference ($19) credited as so much increased capital. But should the returns on the borrowed money be only $75 the question will arise as to how to pay the principal, to say nothing of the interest. Hence the investment of the $100 so as to return $125 instead of $75 is more important than to be able to borrow money at a lower interest rate or without any interest at all! No unproductive enterprise is a safe one on which to borrow.
This discussion leads up to the fundamental rules to be observed when borrowing on credit. Rule Number 1 insists that before seeking farm credit the borrower must be sure that the project for which the money is sought will produce more money than will be needed to pay both principal and interest; for except in rare instances, it is bad policy to borrow for anything that will not pay for itself.
Should money be borrowed for, say, fertilizer under promise to pay before the crops can be harvested and sold, difficulty may arise to pay it. In such cases three events may occur to satisfy the debt: 1, money may come from some other source; 2, the loan or the note may be extended; 3, the creditor may sell out the borrower. The first violates the good business precept that each part of a business should pay its own expenses and a profit; the second asks a favor of the creditor and thus more or less disrupts business arrangements; the third almost invariably results in a more or less heavy loss for the borrower.
Rule 2. Have the repayment date of principal fall when most convenient to the borrower; i.e., when the borrower is most likely to have cash to meet the obligation; as, for instance, when a crop will be marketed.
Closely associated with this rule is Rule 3, duration of the loan, how long it is to run. Should the loan be for a year’s fertilizer it should not run for longer, for should the first crop not pay for it money must come from some other source, otherwise the borrower will never be able to pay for it, thus violating Rule 1. The period should not be shorter than the growing season of the crop because this would violate Rule 2.
Should a machine that will last, say, 10 years be bought on borrowed money each crop upon which it is to be used should pay not only the annual interest charge but a part of the principal—in this case 10%. Small loans of this type should give no trouble and should not require special arrangements for repayment, but large loans, for instance to buy land, build barns or make costly improvements, may entail financial stress, so any method whereby this may be relieved should be considered. One of the best is the long time loan—but not so long as to outlive the improvement!
Should an improvement be estimated to last 10 years it is good judgment to repay the loan in fewer years; for if the improvement will not last that long it will never pay for itself. Conversely, seldom can an improvement pay for itself in one or two years; so unless the borrower has other means he would invite strain to agree to too early payment. The period a debt is to run should be closely related to the productive life of the improvement for which money is borrowed. Thus the borrower may avoid the necessity of renewing the loan, also subjection to an unscrupulous lender who might refuse to renew a short-time loan, but foreclose.
Rule 4. In long time loans provision should be made to reduce the principal in installments. This may be done in either of two ways: 1. The note may state that the borrower may (optionally) repay part of the principal on any interest date. In such cases the amount of interest is also reduced with each payment until the whole debt is canceled. 2. The note may provide for a stated rate of amortization by annual or semi-annual fixed payments, each of which includes interest to its date of payment and also a part of the principal until all is paid. Every borrower of a long-time loan should insist on one or other of these plans. Amortization tables for loans of various durations and rates of interest are available at banks and other financial institutions.
Though Rule 5 is obvious; namely, that as low as possible an interest rate should be secured, its application is not always evident. Interest rates depend upon the law of supply and demand. When the number of lenders is large and loanable money is abundant in a community the rate will be low because borrowers can insist upon lowered rates; under reverse conditions the loaners can raise the rates. Hence the advisability of increasing the number of loaners or the loanable capital, not by denouncing either, but by attracting loaners to the neighborhood. As numbers and available capital increase borrowers may get more favorable terms.
Farmers must disabuse their minds of the idea that land is the best security. It is not! The character and business ability of the borrower in farming, just as in every other business exceed all else. Such men meet their obligations promptly and without legal proceedings, so credit conditions in the community improve as the numbers of such men increase because the right kind of lenders flock to such communities and the “sharks” decamp. The right kind dislike to foreclose mortgages or resort to legal technique. They merely want their principal and interest according to agreement. However, one farmer working alone can rarely do much to attract lenders, but cooperation can. Even so small a group as half a dozen men of sterling integrity, each with confidence in and respect for the other, may work out the problem of local farm credit to the advantage of the whole community.
Suppose we review some ways the business farmer and the local bank may serve each other. Probably “working capital” is the greatest need of the greatest number of farmers. The fact of its usual under-supply, particularly at the start, is the most restricting of all factors to success. Even when it is available it is often badly managed. Properly handled, money makes money; improperly, it loses.
To determine ways to make money in farming the annual budget and the annual inventory are of prime importance. When the farmer starts business and at the beginning of each of his business years (which may be calendar or his own fiscal year, say March 1) he makes his inventory, then estimates his probable gross expenses and income for each month and for each crop or department so as to determine in advance at what time he is likely to be pinched for money, when he will have surplus, when he must borrow and when he can repay. Knowledge of business methods teaches him that hiring money is the same as hiring labor. So he shows both his budget and his inventory to the cashier of his local bank and arranges for loans perhaps months before he will actually need to borrow.
In seeking such working capital he is not asking, but conferring a favor because the banks make money work for them by earning interest and discount on their loans. By loaning money on business enterprises, especially the production business of farming, the bank enables its borrowers to pay their petty bills such as labor and repairs and thus keep their own and the community affairs running smoothly. Still further, as such moneys when borrowed on notes rarely cost as much as 7% at discount rates, the user may make money by paying cash for his bills at 2% discount instead of net at 30 days. This means a 24% gain on the money so spent. Upon deducting the cost of the note (7% or less) from the 24% earned on the discounted bills the remainder is 17% or perhaps 18%. This not only means that amount profit on the borrowed money so used but the enhancement of the farmer’s reputation for prompt payment—always an asset.
But the cashier of the bank is able and glad to serve the farmer in many other important ways. He can replace the attorney in countless cases—and at no cost. In fact, so far as business transactions are concerned he is far better able to advise wisely in financial affairs than are most attorneys! He has such business at his tongue tip all the time. Not only so but he serves his bank when he advises his patrons in their business matters. All he requires is full frankness—knowledge of all conditions that may bear directly or indirectly upon each specific case.
Some of the ways in which he may serve and benefit the farmer are in selling or buying in distant markets by bills of lading and sight drafts, advising as to investments of all kinds, arranging partnership agreements, buying or selling property, joint ownership in specific equipment or breeding stock and countless other business projects.
Finally, the bank deposit vault is the safest place in which to store valuable papers such as promissory notes, deeds, mortgages, insurance policies, contracts, stocks, bonds, and inventories of all buildings on the farm property, these last each brought up to date annually. Always these papers should be kept in a safety deposit box in a fireproof bank. Though the value of negotiable paper is evident and though copies of deeds, mortgages and some other papers may be made, the importance of keeping other irreplaceable documents in the bank deposit box cannot be overstated; for insurance policies and inventories are convincing in case of fire. Never should they be kept where they may be destroyed, stolen, misplaced or lost.