Managing debt is a crucial aspect of achieving success in the ranching industry. James Sewell, a rancher with a strong finance background, shares his insights and experiences on this topic.
James begins by providing some background information about himself. He graduated from college with a bachelor's degree in finance and has been professionally managing ranches for the past 20 years. Recently, he started his own ranching business with his wife, and they are currently in the process of growing it. James emphasizes that his years of experience and accumulated knowledge have contributed to his comfort level with taking risks and managing debt.
Debt, according to James, is a tool that can be used strategically to leverage opportunities and grow a ranching business. He compares his risk tolerance to that of his risk-averse grandmother, who prefers to keep her savings in a bank or a CD. James, on the other hand, sees debt as a means to access capital and invest in opportunities that can generate higher returns. He views interest on loans as the "rent" he pays to use borrowed money.
James highlights the importance of banks and debt in a capitalistic society. He believes that they play a vital role in distributing money to those who have better opportunities for growth and success. He also mentions that his ranching enterprise is just one of his income sources, alongside managing single-family houses and apartment buildings that are rented out. This diversification of income reduces risk and adds stability to the overall financial picture.
When it comes to managing debt for ranching success, James emphasizes avoiding using debt to finance depreciable items such as vehicles, furniture, or personal expenses. Instead, he recommends using debt strategically to invest in appreciating assets, such as real estate properties. This approach ensures that the borrowed money is being used to generate long-term value and returns.
James also distinguishes between tax depreciation and actual depreciation. While there may be tax benefits associated with depreciation on certain assets, he focuses on the real depreciation of items. For example, buildings, if well-maintained, do not actually depreciate significantly. This distinction is important to consider when making financial decisions.
In terms of livestock, James expresses a preference for using debt on stockers rather than cows. Stockers have shorter-term value and can be hedged, making them less risky for debt financing. On the other hand, the value of cows can be more unpredictable over a longer period of time.
To maintain a healthy financial position, James recommends keeping debt levels below 50% of assets. This conservative approach ensures that the ranching business remains financially stable and can withstand potential market fluctuations.
Line of credit for flexibility
One of the key strategies that James Sewell discusses is the use of a line of credit for flexibility. Instead of getting a loan against specific assets, such as cows, Sewell and his wife opted for a line of credit that allows them to sell cows, buy stockers, and trade animals without having to seek permission from the bank. This approach gives them the freedom to take advantage of opportunities as they arise and make changes to their business plan without being constrained by traditional loan structures.
Sewell acknowledges that there is some risk involved in using a line of credit, as the interest rate is not locked in for a specific period of time. However, he emphasizes the importance of keeping the line of credit small enough to avoid crippling the business. He poses the question of whether his business would still be feasible if the interest rate on the line of credit were to increase significantly, highlighting the need to carefully manage debt and ensure that it remains within manageable limits.
In terms of debt-to-asset ratio, Sewell mentions that he aims to keep his personal debt on stockers under 50% of the total value of the stock. He is cautious about becoming too reliant on the line of credit and prefers to keep his leverage at a comfortable level. If he were to become more leveraged, he would consider seeking fixed-term debt instead of relying on a line of credit that needs to be renegotiated annually.
Sewell also discusses the benefits of having multiple non-correlated income streams to support debt repayment. In addition to his ranching business, he has a job with regular income, apartment buildings with good cash flow, and other assets that can be used to pay down debts. This diversified income approach provides him with multiple ways to make debt payments and reduces the stress associated with relying solely on the ranching business for income.
Sewell mentions that he keeps his overhead costs relatively low by not having housing or grocery allowances from his job and by only investing in essential equipment for the business. He and his wife have accepted that some of their profits will be spent on non-essential items, but they ensure that these expenses are separate from the business and do not put a strain on its financial stability.
Sewell's approach to managing debt through a line of credit for flexibility demonstrates the importance of strategic decision-making and careful financial planning in the ranching industry. By using debt in a controlled and calculated manner, ranchers can seize opportunities, adapt to changing circumstances, and build a financially stable and successful business.
Diversify income sources, pay down debt
One of the key points highlighted is the importance of diversifying income sources. Sewell mentions that he has multiple income streams, including his ranching business, a rental business, and another job. This diversification allows him to have a stable source of income even if one of the businesses is not performing well. By having non-correlated income sources, Sewell is able to mitigate the risks associated with fluctuations in the market.
He emphasizes that his rental business is particularly beneficial as it is not correlated with the cattle market. This means that even if the beef market crashes, his rental business will not be affected. This highlights the importance of having income sources that are not dependent on the same market conditions. By doing so, Sewell is able to protect himself from potential economic downturns and ensure a steady cash flow.
In addition to diversifying income sources, Sewell also discusses the importance of paying down debt. He mentions that he uses any profits he makes to pay down fixed-term debt. By aggressively paying down debt, Sewell is able to reduce the amount of interest he pays over the life of the loan and shorten the duration of the loan. This not only saves him money but also improves his financial position in the long run.
Sewell also mentions the importance of paying attention to interest rates and taking advantage of opportunities to pay down variable rate debt. He explains that when he had a variable rate loan on an apartment building, he paid it off as soon as the fixed rate period ended. This demonstrates the importance of being proactive in managing debt and taking advantage of favorable interest rates.
He highlights the flexibility of debt in his financial planning. He views debt as interchangeable within his asset portfolio, meaning that he can allocate debt to different enterprises based on where it can be obtained at the cheapest rate. This flexibility allows him to optimize his financial resources and make strategic decisions based on his specific needs and goals.
Total debt load matters most
One key takeaway is the emphasis on the total debt load. According to Sewell, it is crucial to consider the total debt load when managing finances in the ranching industry. This means looking at the overall debt across different areas of the business, such as loans on apartment buildings and loans on cattle.
Sewell suggests that it is important to prioritize paying down the highest interest rate debt first. This strategy helps to minimize interest expenses and reduce interest rate risk. While it may be tempting to pay off debt on an apartment building faster, for example, it may be more favorable to keep that money and use it in another area, such as investing in cattle.
The allocation of debt does not necessarily matter at tax time. Sewell explains that the choice of where to put the debt lies with the manager or owner of the business, not the IRS or anyone else. While it may affect the appearance of different enterprises, it is ultimately up to the individual to decide where to allocate the debt.
Sewell also highlights the importance of considering the big picture when managing debt. Instead of looking at each aspect of the business separately, he suggests looking at the entire balance sheet and assessing how net worth has changed over time. This approach allows for a comprehensive evaluation of financial performance and helps to determine the overall success of the business.
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