2 March 2001

CHANGES ARE KEY TO STAYING SOLVENT

What are the prospects for

arable farming in the UK?

Glimmers of hope are

appearing, but producers

still need to focus on

changes to survive.

Charles Abel finds out more

from a leading adviser

HAVE arable farm incomes bottomed out? A leading business consultant believes they may have done, but stresses that farms still need to look at what they are doing to seek the efficiencies that will keep them in business.

"Facing the future in farming is extremely challenging, given the general decline in farm incomes and the worst autumn on record," acknowledges Chris Winney, senior business consultant with ADAS.

However, he believes the downturn may have dipped as low as it is likely to go. "There are a number of issues that do give some optimism for the future."

To support that view he points to data for UK real farm incomes over the past thirty years. Most analysts put a trend line on it that shows an inexorable slide in incomes, predicting worse to come." (See graphic).

"But look at the 1970s, that is when most of the income was lost. Remove the highs of the 1970s and the trend line becomes almost flat."

There has been volatility around that trend line, he admits, like the record yields of 1984, leaving the European exchange rate mechanism in 1992 and market demands and currency effects in 1995/6.

Furthermore, volatility has increased since 1993, mainly in response to currency moves. "There lies a message for the future," he notes. "Currency has been, and will continue to be a key driver of farming fortunes."

But recent price rises in the grain market in response to global demand and changing currency values may signal the end of the downturn, he suggests.

"I think we are seeing something of an upturn. If I had a crystal ball I think I would be saying we can expect a return to 1989-92 profit levels in the medium term."

Although those income levels were uncomfortable for some, the biggest problem today is the sharp contrast between current incomes and the exceptional profitability of the mid-1990s, he notes.

But currency, which plays such a key role in crop values (see graph), is finally working in favour of UK growers. Having dropped from an original value of 1k being worth 70p to a low of 57p last September, it had returned to 64p by late Jan.

"There is some encouragement in that. It is moving the right way, driven by the slowing American economy and some increase in Euroland confidence," says Mr Winney.

But welcome as the currency change is, it is outside the control of farmers. Internal issues are different. With technology and good advice productivity can improve and changes to the business can boost business profits.

Farming is not unique in that, stresses Mr Winney. "Look at other manufacturing industries. More mechanisation, more market focus, more specialisation and larger operations. Whatever you may think and feel exactly the same is happening in farming across Europe."

Indeed, MAFF statistics show farming is fast approaching the 80:20 rule. "Were not quite there yet, but with 28% of the largest cereal farms producing 75% of output we are heading towards it."

That is putting pressure on medium-sized business in particular. "They are being squeezed to move up or down, either to go part-time and find other sources of income from non-farm work or diversification, or to move up and develop new opportunities."

Finding an appropriate response is the key to future business success, says Mr Winney. His advice is to plan for change, but to be sure what sort of change will be best for your business and also how best to achieve it.

The key question is which way to go? To ease that decision Mr Winney splits the options down to just four, involving new or existing land and/or markets and new or existing products and/or operations (see table above).

"Businesses need to be clear about which of the four boxes they see themselves in and then set clear goals and plans for getting there. They need to be prepared to move between boxes and to take opportunities as they arise. If they do there will be a strong future for them," Mr Winney concludes.

1. Same market, same system

Often described as consolidation, this is fine if it follows recent expansion. But too often it is a grand title for something rather comfortable. In the long-term it is likely to lead to the business slipping backwards, rather than moving forward. For some businesses there is scope for growth by improving technical performance with cost control, but in the medium term farms need to move out of this box.

2. Existing market, new products

Described as product development, this is clearly happening in farming, as seen by increasing specialization, particularly in the potato and vegetable sectors. New and more intensive methods are resulting in higher standards of production at lower costs and greater differentiation between products. Although not yet widespread in grain markets it is developing, with new technical requirements creating specific market outlets for different grades of crop. In land use terms it often means an increase in scale.

3. More land, existing system

Market development involves farming more land through land purchase, rental or contract/share farming. The biggest advantage is that it involves existing products and operations, so is a familiar business activity. It does not necessarily need new skills, but a build on existing skills. A key issue is whether the additional land contributes to profit. A profit may seem apparent after marginal fixed costs are deducted from extra gross margin. But the risk is that the expected gross margin may not be achieved, because crops fail to match expectations due to over-extended capacity, input errors, inferior rotation or seasonal factors. Any extra financial pressure in future, such as when machines need replacing, also needs considering. This can be the hidden cost of expansion, only becoming apparent when an existing machine is replaced with a larger, more costly version to achieve a viable workload. Growers also need to check whether farming more land fits with personal or business objectives.

4. New market, new system

This is diversification, which gets talked about a lot. It receives grant aid and is getting further support through the Rural Development Programme. But while it provides excellent business growth opportunities for some, it is not for all. New markets and new products bring new risks. Time spent on thorough research and planning is crucial. Key questions include:

&#8226 Is the development backed by a sound existing business?

&#8226 What is the market and where is it located?

&#8226 Can the product be produced?

&#8226 How much competition is there?

&#8226 What are the capital requirements?

&#8226 What is the payback period?

&#8226 What cashflow is required?

&#8226 What are the risks and how can they be minimised?

&#8226 What help and funding is available? &#42

Short-term survival

Two key issues need addressing to ensure short-term survival, says Mr Winney:

Balance sheets: "Check your balance sheet now to see what is happening to the money in your business. With profits down many businesses are delaying machinery replacement to save money. That reduces costs without increasing liability, but is drawing on the stock of machines, reducing the asset value of the business. Alternatively overdrafts, loans and creditors may be increasing, with money switching between liabilities so loans are covered by an increasing overdraft. It is important to look at all figures to see how the balance of your business is changing." His target for land-owners is for equity to be greater than 70% of asset ownership. "If you have slipped towards 70% that is going to be difficult to trade out of." The same applies for tenants at 50%, because land and property are not included in the overall figure. "Look at the figures and look at the trend to see where the business is heading."

Timescales: Check when the full financial effects of low prices will hit the business, he advises. "It can be quite slow for cash effects to work through to the bottom line, taking up to two years from planting. If the crop is sold in September for payment next year then peak overdraft demand could be as late as July 2002. That needs to be looked at in the context of decisions about set-aside versus spring crops this spring. Growers may need to look at cash payment deferral, more borrowings, alternative funding or asset sale."