Farm Finance

By Ian Ashbridge

MANY FARMERS could face a long gap between the last IACS receipt and the first single farm payment cheque.

The payment window for the SFP opens in December 2005 and closes in June 2006, up to eighteen months after the last IACS cheque is signed.

Bankers‘ and accountants‘ advice is clear: Be prepared, start planning now and get talking to your lender. 

Edward Jenner, rural business manager with accountant Bentley Jennison, says CAP reform is likely to have an adverse effect on many farms’ cash flows, and in reality, the single farm payment will be worth less than current support.

“While the situation will vary for farms with a mixture of enterprises, a good proportion will find cash flows on the negative side.

“DEFRA is aiming to work to the beginning of the payment window, but overdrafts will still become stretched. Many farmers will need to talk to their banks and put extensions in place.”

This lean period between payments will not only affect cash flow, but could put pressure on management decisions, says Mr Jenner.

“It may also restrict investment in new machinery and services. If the SFP is delayed right up to 18 months, it could also affect cropping purchases such as fertiliser.”

In some cases, overdrafts will already be stretched to capacity and the long wait for SFP support could mean the end of the road, he warns.

“And for the majority, the SFP will be worth less as the regional element is built in. Modulation will take funds straight off the bottom line, and farms will have to adjust to less cash coming in.”

Protecting business health will mean preparing carefully and planning as accurately as possible, says Mr Jenner.

“From January, prepare budgeted cash flows and a business plan for the farm, setting out what is going out and when, and when funds will be received.”

This will highlight anticipated peaks and troughs in farm income, and be welcomed by the banks, he says.

“Go and start talking now to be prepared. Once you have worked out what your single farm payment will be worth, approach your bank.”

There are several borrowing options available, he says (see box, below)

But borrowing facilities will need to be put in place as soon as possible to avoid paying banks‘ penalty charges if negative cash flows force the farm to exceed its agreed overdraft, says Mr Jenner.

Forward-selling produce on contract at an agreed price could help alleviate problems, but this is not without some risk.

Taxation treatment of the SFP could add to pressures on cashflow between support payments, although the Inland Revenue has still to announce exactly how it will handle the new support.

Interest rates are also up. “The cost of servicing borrowings is higher than a year ago. Banks will have put their rates up accordingly and some people may be forced to accept a more expensive arrangement.”

Above all, Mr Jenner‘s advice is clear. “Be realistic and be prepared.”

Advice from the banks

Establishing the worst-case scenario will be the key to managing the delay in support payments, says Steve Ellwood, head of agriculture at HSBC Bank.

“Talk to your bank as soon as you can,” he advises. “We don‘t know when the SFP will arrive. So the only assumption you can make in your projected cash flow is that it will arrive at the end of the payment period. You have to assume the worst.”

It will be much easier to help customers who have mapped out when the crucial points in their farms‘ cash flow are likely to occur, he adds.

“Cash flows can be managed by delaying payments for fertilizer and pulling forward receipts for crops. But farmers need to be convinced this is sensible for the overall profitability of the business,” says Mr Ellwood.

Banks are likely to favour organised farmers, that know the likely value of the SFP and have planned well, when extending credit lines to help them through the lean period, he says.

Euryn Jones, director of agricultural policy at Barclays, has prepared projected borrowing figures for British farming at the time when IACS would have arrived next year.

The hike in lending is more pronounced to the arable sector, but livestock farmers are also expected to borrow more (see graph).

“Barclays is forecasting that agricultural borrowing could rise by £1.3bn in autumn 2005, at an extra cost to the industry of £20m,” he says.

“It‘s not just about forecasting what could happen, but about taking action to cope with the threat.

“Businesses can use a number of measures to manage cash flow, such as changing sales patterns or borrowing.”

Farmers have access to numerous borrowing options, says Mr Jones. But for most, an overdraft extension will be most suitable to cover a relatively short-term delay in income. And costs of borrowing may not be too onerous for farmers, he adds.

“Farmers tend to enjoy competitive rates compared with other sectors of business.”

Producers can also take advantage of merchants’ credit facilities when buying inputs or selling grain.

“There are a number of sources of credit available, but farmers must compare all the costs of borrowing – not just the interest rates.”

For example, arrangements fees can increase finance costs. “Compare like with like,” says Mr Jones.

Overdraft extension

  • Contact bank and request quotes for overdraft set up or extension

  • Should seek overdraft rates up to 3% about over base – likely to be variable. Rates depend on security. More than 3% over base is very high

  • Shop around. 0.25% could mean a lot of money

  • Rates often negotiable with banks but will depend upon risk profile of individual business. The more stretched the overdraft, the higher the rate is likely to be

  • Downside – banks often charge arrangement fee as a set % of requirement. This could be around 1% of agreed facility. A necessary evil?

Conversion of debt

  • If overdraft already stretched, may be possible to convert some of overdraft to fixed-term loan. Eliminates risk of increased cost due to rising interest rates. Best rates perhaps 2 – 3% over base

Re-mortgage land and buildings

  • May obtain personal residential mortgage on farmhouse. Could achieve cheaper source of finance, with discounted mortgage rates available, below bank base rate

  • Downside  – repayments may be high as 25-year mortgage may not be available depending on the age of applicant

Suppliers‘ credit terms

  • Negotiate more flexible terms with suppliers. May be able to get more than one  month‘s credit, depending on credit history. In a competitive market, this may give the supplier the edge over a competitor

  • Extended credit terms may be available. Almost certainly involves interest payment – likely to be more than bank overdraft rates, but less than credit cards

Loan sharks

  • Beware of unscrupulous lenders. Provide short-term relief but often charge very high rates of interest

Credit cards

  • Expensive form of short-term credit facility. Look carefully at the APR rate. Best cards below 10% APR, but many are much higher. Expensive form of credit

Sale of crop via co-operative

  • Normally able to receive advances on sales contracts to assist cashflow. For example, may get % September advance with December or November delivery

Forward contracts/futures markets

  • Products sold at a set price today for delivery at some point in the future. Not finance but will guarantee cash flow

  • Risk that market may move in adverse direction so that the spot price on day of delivery is more than that agreed in forward contract

  • Can use futures markets to buy at a price set now for delivery

  • Again, not source of finance but provides security of cashflow

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