‘Alternative energy’: The power of self-finance (In the Money column)
By JON STONE GOFF
President, Remuda Financial Inc.
The theme of this supplement, alternative energy, obviously refers to the current practical considerations of the kinds of physical energy that run our homes and farms, most notably electricity and petroleum-based products.
But — as you might expect a financial columnist to point out — there is a more elemental form of energy to consider: The power that drives everything. Financial energy provides for all the needs of our lifestyles and productivity including the purchase of physical energy products.
Alternatives aren’t usually considered in the context of financial energy. What alternatives can exist? We can’t decide to use another country’s currency, at least not without some difficulties in our transactions. Very few of us would consider going back to the times before common currency existed, when the barter system provided for the needs of self-sufficient farmers.
So, when we think of alternative forms of financial energy, we’re really thinking of alternative ways to flow money into our enterprises and of alternative ways to make that money as productive as possible — while keeping the most money we can at the end of the day.
All farms survive on the flow of revenue and expenses, with occasional needs for larger amounts of money for major purchases or investments. For those, we seek a pool of available capital that can serve our needs at “the most reasonable” cost.
The most common pools of capital are controlled by commercial banks that lend out money at the price of an interest rate that covers their expenses and sends profit to their owners. The banking system works well to capitalize many kinds of purchases, as long as borrowers don’t mind paying all the interest on their loans and they continue to ignore the lifelong opportunity costs of those interest dollars.
As alternatives to conventional financing, a farmer may consider the range of ways to use money:
Save up to pay cash for purchases. The practicality of this approach is limited by the size of the purchases — saving for a needed piece of equipment can cost valuable productivity in the meantime. And using savings for purchases is considered the classic “sinking fund” method for obvious reasons.
Lease production equipment. In this method, ownership of the equipment is retained for the lessor while the lessee obtains its use but not its value. Leasing is the most expensive way to acquire the use of a product.
Finance the purchase by obtaining a loan. This is the most common way Americans buy anything, whether on a credit card whose repayment is stretched into the future, or through a loan from a bank or other financial institution that charges interest and sometimes fees to originate the transaction. The real cost of a loan as previously mentioned is the “opportunity cost” of the money paid in interest and fees that could have otherwise been used.
Another way to gain access to a pool of capital is to transfer some part of property value into liquid form. The most valuable asset of any farm family is typically its land. But equity in the land is “lazy” value because it just sits there without doing a lick of work. Most fail to realize that the rate of return on real estate is zero.
Refinancing a farm mortgage can free up some of the equity and put it to work. In a low-interest environment the mortgage payments can usually be reduced even when a chunk of cash is included in the new loan. However, if that money is spent as another cash outflow to make the farm more productive it’s just another kind of sinking fund that will again be lost to future use and earnings.
Farmers have another option available: sell the future development rights of their land so that it will remain in agricultural use forever. The instrument is called a “conservation easement” because it is used to conserve farmland and prevent development that would be considered environmentally more harmful. Typically bought by conservation-focused land trusts, although it does offer fairly large pay-outs, this option creates potential control issues and limitations as well.
Either refinancing or selling private property rights can leave a farmer with a considerable pool of capital, but what then? How can the farmer use that money to serve future productivity and cash flow, maintain farm ownership continuity and protect the interests of future heirs?
An example of this kind of alternative financial energy will be discussed in the next column. In the meantime, what are your thoughts on the concepts shared regarding “alternative financing” as a possible benefit to you? What options do you feel are available and realistic in generating additional positive cash flow on the farm and why?
Your questions or comments are welcome. Join the discussion at The Delmarva Farmer’s Facebook discussion page. Find a link at the paper’s website here.