This month, Farmers Weekly’s experts give advice on financing new machinery purchases, fire insurance, grain marketing and storing non-farming equipment in barns.
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Weigh up ways of financing new machinery
Q I want to buy new machinery, how should I finance it?
A When purchasing new machinery there are several ways in which you can finance the asset.
First, you may choose to purchase outright. You will need to ensure cashflow can support this as it will mean a loss of cash to the business immediately but will provide you with comfort in knowing you do not owe someone money.
Consider this option very carefully, as you may miss out on other opportunities to use the cash, such as unforeseen drying costs on crops or parlour repairs. Using cash this way will therefore produce an opportunity cost that may not be calculable at first glance.
The tax benefit of an outright purchase is that you will be able to claim capital allowances, which can be claimed in full if you have not used 100% (£500,000) of the annual investment allowance, to reduce your tax liability.
Second, you could purchase machinery on a hire purchase or on a finance lease agreement, where a deposit is paid upfront and regular repayments are made.
A hire purchase agreement will mean the asset is capitalised on the balance sheet, and depreciated yearly against the profit and loss account. The associated debt will also have to be shown on the balance sheet but the net cost owned by you will show the value you have added to the business.
This approach will help you to maintain cashflow and potentially give opportunities to invest in other areas of the business. With very good financing deals to be had at the moment, which are either interest free or on very low rates, this could be an attractive option.
The effect this option has on your tax liability is that relief is given in full on the initial cost of the asset. But where companies charge interest on the agreement, this interest is also deductible against tax.
The third option is to take out an operating lease agreement. This is where you pay a “rent” to the lease provider for the use of the asset.
Unlike the first two options, the asset does not belong to you at the end of the agreement. With potentially large monthly payments, do you want to pay for something you will not own?
Here, the accounting and tax treatments are the same, as each payment is shown as an expense in the profit and loss account, with 100% tax relief claimed on each payment. There is no relief given upfront like the other options.
Care should be taken with leases where there is an option-to-purchase fee as these are slightly different to normal operating leases for tax purposes.
Check your insurance levels
Q Our insurer won’t pay the full value of a fire claim that happened in June because they say we were underinsured. The fire was in one of our listed farm buildings and we didn’t have enough cover for restoration. But we are being forced to rebuild the barn. Why won’t they pay the sum we were insured for?
A Underinsurance is typically the biggest barrier in arranging settlement of claims, which is why it is important to set realistic reinstatement sums insured.
Farmers & Mercantile
When an insurer is calculating a claim settlement, they look at the total value of the insured item and compare it to the value of the loss. They will then look at the amount the item was insured for. Regardless of whether or not the total value of the item has been lost, if the sum insured is found to not reflect the true value then insurers will apply what they call “average”.
This is how it works: if you insure a farm building that has a rebuild cost of £100,000 for £75,000 and then suffer fire damage of £30,000, you will receive £22,500 in settlement. This represents 75% of the claim as you have paid a premium based on 75% of the value. The remainder of the financial loss, £7,500, will not be paid, leaving you having to find the shortfall.
Agrical loss adjusters work across the country and see many instances of underinsurance. They say that common mistakes when setting a sum insured are:
- thinking I did that work or built that myself, so it didn’t cost anything
- believing concrete won’t burn
- arranging cover for “vulnerable crops only”.
Some farmers arrange cover for their crops based on the value of those they believe are vulnerable to fire, making no allowance for root crops, such as potatoes. However, the most significant claims for crops that we deal with arise when the crops are in store and equally vulnerable.
Last but not least, undervaluation of livestock and deadstock is also common. This often seems to occur when policies are renewed in the winter, when livestock numbers on beef and sheep farms are typically at their lowest.
It may well be that the cover arranged is adequate when it is set, but if no allowance has been made for the value of youngstock that will be born and grown on later in the year of the policy, substantial underinsurance can arise.
Unfortunately, inadequate cover for traditionally constructed farm buildings is all too common. These structures often have development potential and, if that’s the case, they should be covered for the full cost of demolition, site clearance and rebuilding using traditional materials.
Adequate cover for traditional reinstatement is particularly important if buildings are listed, as their owners can be compelled to rebuild them if they are damaged or destroyed.
Non-farming storage in barns
Q I am a farmer and for many years I have used one of my barns for the storage of non-agricultural items for the benefit of local businesses. Most of the time I have charged for this but sometimes it has been free of charge. The items stored have been things such as vehicles, furniture, electrical white goods and so on. My accountant has now brought it to my attention that this might need planning permission. What are my options?
A Your accountant is right. The storage of non-agricultural items such as the ones you have named require planning permission except if you only undertake the storage for a maximum of 28 days in a year, then you could do that under the relevant exclusion. This is true whether or not you are paid for the storage.
Head of agriculture
Bear in mind this would also potentially give rise to a business rates charge and this could be applied retrospectively, too.
As you mention your accountant, I assume you have taken advice on taxation of the income generated.
Assuming you want to carry on with storage, one possibility would be to obtain retrospective planning consent through what is known as the prior approval procedure, although there are qualifying criteria that must be satisfied. The local planning authority may also require further information on issues such as transport, noise, contamination and flooding.
If you have been using the barn for this purpose for a continuous period in excess of 10 years then you can apply for a lawful development certificate (LDC). This is not the same as planning permission, but if an LDC is granted, the use is conclusively presumed to be lawful and may therefore continue. Note that if you were to subsequently change back to agricultural use then you would lose the benefit of the LDC.
This option is worth considering, providing of course you have the evidence to back up such a claim. It is important that all paperwork and records relating to the use are clear and show the period of use.
The onus is on you to persuade the local authority that a certificate should be issued. The evidence needs to be clear and convincing, and in a case like this I would expect to see sworn statements, preferably with contemporaneous documents (such as diaries, invoices, receipts) supporting the facts alleged. It is also important the evidence is sufficient to satisfy the 10-year period as a failure to do so may jeopardise the grant of the LDC. To this end, it is imperative that any interruptions in the use of the building during the 10-year period are scrutinised before submitting the LDC application.
It is important to consider all the facts before applying for an LDC as an unfounded application may give rise to enforcement action.
In turn, if such action gives rise to an enforcement notice and you do not comply with it (a criminal offence) then this raises the spectre of the Proceeds of Crime Act 2002 (POCA). Widely regarded as a powerful piece of legislation, the POCA allows regulatory bodies to track down and recover the ill-gotten gains of criminals.
Increasingly, however, POCA has been brought into play in cases such as your own. There are now numerous examples of local councils within a planning context using their powers to freeze – and where appropriate, confiscate – the assets of those who receive a financial benefit from crime. The court will look carefully at the sums made in contravention of the notice. So the ramifications of not complying with an enforcement notice in cases such as this, whatever the perceived reasons for not doing so, need to be carefully considered. Also be aware the council can invite the court to look at income going back six years within a POCA application.
Grain marketing tools explained
Q Grain prices are so volatile, how do I manage my risk? There are so many options to choose from, such as forward contracts, pools, options, minimum/maximum and minimum contracts and futures. What do they all mean?
A Start by determining your cost of production. The difficulty will be allocating the fixed costs. Machinery costs are easy to identify, but you also need to allocate costs such as insurance, water and energy. Also allow an appropriate margin for profit and reinvestment – this gives you your target price.
Next, look at cashflow. Cash should never fully influence your marketing strategy but you might need some early sales for cashflow in early autumn.
Pools allow you to spread your risk and “contract out” the decision to someone who spends their working hours watching the commodity markets, allowing you to focus on your business. You can select short, medium or long pools, which affects the timing of when you are paid. The big question to ask is how does their price in the past compare with others?
Options are more complex and are insurance against changes in future prices. You buy insurance at an agreed price and sell (or agree to sell) your crop at a certain price. It gives you a minimum price with the potential of achieving higher prices. So if wheat is trading at £130/t and the option is £10/t, you receive a minimum price of £120/t. If the market rises to £150/t, you secure an effective price of £140/t.
If you think the market will fall you are better selling the crop forward. The questions you need to ask are:
- Is it likely the market will move more than the cost of the option?
- Is the company I am dealing with financially secure with the resources to honour the option?
Minimum/maximum and minimum-price contracts are effectively an option directly with your grain merchant. Min/max contracts set a range of the price. A minimum-price contract gives a minimum price and usually involves “sharing” the upside with the merchant. With this type of deal make sure you read the small print and fully understand the terms of the contract.
The most important piece of advice is do not chase the top of the market – just seek to secure a price that delivers you a sustainable profit.
The information provided in these articles does not constitute definitive professional advice and is provided for general information purposes only.
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