17 November 1995

DONT BUY ON WRONG BASIS

Having decided what machinery to buy, the difficult question is how to pay for it. Suzy Horne takes a look at the world of finance and discovers some timely advice.

THE machinery finance market is struggling to hold its own against farmers with cash in their pockets. Where a new machine is replacing a trade-in and the balance is small, then it is more often being financed out of cash rather than on credit.

But many people are buying and making decisions on the wrong basis, warns Simon Bennett of agricultural accountant Touche Ross.

"It could be that the bank is willing to lend the money, they have made good profits, or the balance looks good at the time. But many farmers have not planned for the large tax bills which will be hitting them nine months after the financial year end for companies, and 18 months after the financial year end in the case of sole traders and partnerships.

"You should consider the cash flow needs of the business – there might be other calls on cash," advises Cambridge-based Mr Bennett.

He argues it is a false assumption to think that investment must be carried out now just because the cash or finance is available. If times get bad, then that money would still be in the bank if it is not spent on equipment now. In addition, machinery may be cheaper if farming comes under further pressure in future.

Hire purchase recently overtook leasing as the most popular method of funding machinery. HP and outright purchase both offer tax advantages over leasing because of the current regime where sole traders and partnerships are in transition between two bases of tax assessment.

Contracting, contract hire or leasing are all treated as tax expenditure to the year in question. Under the rules of the transition period for changing from previous to current year assessment for income tax, relief is lost on half the contract or lease payments. However, full tax relief is retained on assets bought outright or under HP agreements, where tax relief is given on capital allowances, points out Mr Bennett.

"This is a complex area," he says, "and I would recommend that farmers take their accountants advice if they have not already done so."

There are still many subsidised schemes in the market, and still a great deal of confusion about true interest rates and the actual cost of finance.

"It is common for say three of 36 monthly payments to be made on signing by way of a deposit," says Roger Coleman, general manager, agriculture at JCB Credit. "On a £36,000 machine, over say three years, that actually means you are only borrowing £33,000 for 33 months."

Buyers should check that they are not being charged interest on the total price for the total period of the agreement. Deposits and trade-ins should come off first, and asking for a true rate is safer than relying on a flat rate, which will vary.

Most finance is quoted at a flat rate, which usually works out at around half the true rate. The true rate, or APR, can be compared against alternative costs of borrowing to ensure the best deal.

Where subsidised credit is available, it is being offered for a reason. It may be that a particular machine is not selling fast enough, or that a new model is being launched, or a manufacturer may want to buy market share and uses this method to achieve that share.

Mike Greetham, a farm business consultant with Andersons, advises that when considering finance arrangements, farmers should first check that the size and type of the machine is right for their business – a change in acreage farmed could throw out machinery capacity, and there may be heavy penalties for getting out of an agreement early if the machine has to be changed.

"Farmers are often anxious to own machinery which ultimately has little financial advantage," says Mr Greetham. "By hiring, and in particular contract hire, it is often possible to leave the insurance and repair liability with the finance provider."

He also points out that it is possible to include non-performance clauses in hire purchase agreements, so that if the machine fails to operate satisfactorily, the finance provider is obliged to replace it with an alternative. This might be particularly important with seasonal machinery or that used on harvesting high value, high risk crops, for example.

Leasing usually results in the farmer having a financial stake in the machine at the end of the agreement. Those using contract hire should consider using a sinking fund to arrive at roughly the same financial position as if they had leased. That way, they will have cash to put into the replacement machine when the time comes, advises Melton Mowbray-based Mr Greetham. This also needs to be taken into account when looking at the cost of leasing against contract hire.

"Agreements usually rely on the sanction of the finance provider being able to remove the machine in the event of default, but some farmers have been able to circumvent this," says Mr Greetham. For example, a leased grain-drier may not be removed from a farm if that removal results in damage to third-party property.

This is particularly relevant on tenanted farms where the landlord may have financed or contributed to the building or casing surrounding the dryer. However, leasing companies are now more wary of getting into such situations, and will often require a landlords waiver. &#42


Checklist for machinery investment

lDo you really need a new or replacement machine or are you being encouraged by the easy availability of finance or cash?

lIt may be a false economy to gear up now while times are good, in the supposition that this will help you ride out poorer years in future – you could be building up a depreciation burden which the business will not be able to afford.

lConsider refurbishment or updating, sometimes this can be accounted for as repairs instead of capital expenditure.

lMight a contractor or short-term hire be a better option?

lBeware of huge discounts. Look at the actual cost rather than what you are being told you are saving off the list price.

lHigh initial cost can mean high trade in value. Consider this alongside how long you are likely to keep the machine.

lCheck the small print of agreements, they are legally binding.

lCan you get out of the agreement before its term is up? Watch out for penalties. Leasing is a tax-based product, early settlement will deprive the manufacturer of capital allowances and so may be punitive.

lIs the finance house financially secure? If it folds, the equipment under the agreement is technically the finance companys property and may be removed.

lBeware of being impressed by inflated part-exchange prices. They could simply be made up of discount.

lUsing the manufacturers finance scheme may help in the event of a dispute.