USAID – Workshop on agricultural sector financing BRIEF INTRODUCTION TO AGRICULTURAL FINANCE Workshop on July 22 and 23, 2011

INTRODUCTION/DEFINITION Very simply: “Agriculture is the production and processing of food, food products and (bio) fuel”

MEET AND SERVE BASIC NEEDS Food is the basis of the Maslow pyramid for human needs Demand never disappears The development of a society both socially and economically accelerates the demand for agricultural production More quantity produced More sophisticated production

SEASONALITY There is no probability that for each sector, this will be a good season! There is no probability that the following season will be the same! There is no guarantee that after a poor season, there will be a good season… …the same is true for good seasons… …but in the end, from the Long-Term perspectives, the accumulated results are always positive

SECTOR TRENDS If the prices for grain are high: - Each decides to produce grain in the following season - Simultaneously, pork production does not become profitable (herds are reduced) The following season, we have: - Overproduction of grains = low prices - Extremely high profitability for pork production But - Production substitution

SECTOR CORRELATIONS High grain prices, good season for grain producers Poor season for meat producers But for which producers? - poultry producers - beef producers? High prices for apples, good season for apple producers Poor season for apple producers, good season for banana producers

TECHNOLOGICAL TRENDS Move from manual production to mechanized production Move from mechanized production to industrial production

CHARACTERISTICS OF AGRIBUSINESS Agriculture is an activity like any other. It needs equity, management, cash flow and to be profitable. The financial analysis of major agrifood structures is done by the analysis of Balance Sheets and Income Statements. For small structures and farmers, the analysis used is typically that of cash flow and of income from harvests

CHARACTERISTICS OF AGRIBUSINESS Agribusiness has unique characteristics that call for the specific attention of the client manager and of the credit analyst and that are: Management Seasonality Perishability Location and the needs connected with the location (infrastructures)

MANAGEMENT The key factor in a successful agricultural business is the management. In addition to healthy management, agribusiness calls for expertise in: Farming or animal husbandry Human relationships to ensure the supply of products Processing the harvest and/or transformation Marketing (Commercialization) It generally requires years of experience in order to become an effective farmer/agribusiness. The lender must take this into account during the approval process.

SEASONALITY Agricultural production and consequently processing and transformation are generally seasonal. In order to know when to make the right amount available at the right time (ex. financing operating needs), the lender must prepare: The budget The cash flow Seasonality also implies that the banker: Be proactive in examining and putting credits into place Manage market changes React quickly to changes in credit demand

PERISHABILITY All agricultural products are perishable. The lender must take this aspect into account, ensuring that the agribusiness rigorously responds to the following concerns: Harvest manipulating techniques and equipment Storage Management of storage techniques Appropriate transport Proper management of time/time limits with the transformers

LOCATION An appropriate location is a vital element in agribusiness. The location may be influenced by: Water and climate Infrastructures (transport, storage, etc.) Cultivation methods Historical references Support of industries and markets

THE LOAN EVALUATION PROCESS The evaluation of a loan, as for any other evaluation, implies 3 distinct phases of analysis: Intuitive Qualitative Quantitative

INTUITIVE PHASE Probably the most important phase. Quite simply, this requires the analyst to look at the proposal, to think about it, to draw from it an experience and to ask the question “does it make sense?” The answer will have an enormous influence on the rest of the process

QUALITATIVE PHASE The qualitative analysis considers the intangible (immaterial) portion that is part of the evaluation process. In addition to other factors, the client manager and the credit analyst must take great care to correctly evaluate: Business management competencies Agricultural competencies Marketing (commercialization) Supplying of raw materials Placement

QUANTITATIVE PHASE The final phase is used by all bankers: “Crunch” the numbers Evaluate the guarantees

THE CLIENT RELATIONSHIP The loan for agricultural structures calls for a good relationship between the lender and the borrower. Both are responsible for communicating openly and clearly. A good lender understands agriculture and the problems with which the borrower may have to deal. You must take time to understand the situation of your client.

“TIPS” FOR A GOOD CLIENT RELATIONSHIP Use simple everyday language to explain things, not banking jargon Do not assume that agro managers do not understand finance Explain why the application is rejected and what can be done to have it approved Take time to build a relationship Learn to understand agriculture and the place of farmers and agro managers in the industry Go out and visit the farm/establishment of your client If possible, learn about neighboring farms, suppliers, buyers Recommend your relationships to management centers, to structures for strengthening capacity

WORK WITH YOUR CLIENT ON ESTABLISHING CASH FLOW Help the farmer establish an accurate set of books or ledgers for the business. For the more formal agro structures, assign them to a good accountant/management center Review historical performance with the client - by activity - Financial statements and/or cash flow and harvest income - Calculate the basic ratios - Establish comparisons with competitors, with neighbors, or with established standards/trends - Establish unacceptable variance standards - Develop strategies to take corrective actions Listen to your client’s ideas and suggestions Understand all of the other activities and family needs Regularly sit down with the farmer and review actual vs. expected performance