A shaft of light shines through the gloom of low arable incomes for those considering new farm investments, writes Mike Bird.
THE prospect of monetary union sooner or later, albeit beyond the term of the present parliament, means that longer-term interest rates should continue to converge with those of our European partners. Meanwhile, UK rates remain close to their lowest level for 20 years.
So in terms of net cost, there has rarely been a better time for farmers to invest, locking into low fixed rates of interest that are guaranteed not to move over the life of a finance agreement.
Inflationary pressures mean that bank lending rates are expected to continue on an upward path. This places an even greater strain on those who rely on short-term variable rate funding to finance the day-to-day needs of their business – and any major new investment.
The fall in arable incomes, although unpleasant, has not come as a total surprise. Many prepared for it when times were better by investing in modern specialist machinery, plant and equipment designed to add quality and value to crops and produce.
This foresight is one of the major reasons why the top performing arable units are seeing far lower falls in income than the average, which will help them ride out the recession.
Such farms understand the need to maintain investment within their core business and will be better prepared to take full advantage of the upturn, when it arrives.
However, Keith Jaynes, marketing manager of ING Farm Finance, stresses that every investment decision needs to be fully cost-justified, especially when farm incomes are under pressure.
"This does not mean abandoning all machinery expenditure when times get tough," he explains. "We recommend that growers establish clear and realistic management objectives together with a sound business plan setting out precise targets over a reasonable time period. That done, there is no reason why farmers should not continue to invest in new equipment to take advantage of the available opportunities, spreading the cost to match the expected life and return from the investment."
Mr Jaynes points out that those currently feeling the pinch can take a measure of comfort from the fact that farming has traditionally experienced up and downs. Yet, incomes have always recovered, accompanied by a heightened desire to improve productivity, quality and efficiency.
"But these three objectives cannot be turned on and off like a light switch," he says. "They need to be planned for both in good times and in bad by continuous improvement of the core business. That means maintaining steady investment through thick and thin to enable maximum advantage to be taken of every opportunity to boost income and profitability.
"Anyone who relies principally on cash or short-term borrowing to fund new investment will have few spare resources available at a time of severely restricted incomes. Even if they appreciate the importance of continued investment, it is unlikely that positive action can be taken without seriously affecting cashflow in the short term."
The findings of a 1994 report prepared by Cranfield College and 3is (Investors in Industry) remain valid today. The report pointed out that small businesses placed far too much dependence on short-term sources of capital to fund investments which have medium to long-term returns. Although a business might be profitable on paper, many failed simply because they ran out of liquid cash.
"When incomes are down, maintaining a healthy cashflow becomes even more important," says Mr Jaynes.
"The most efficient businesses recognise that there is little point in buying outright a machine which has a projected pay-back time of three or more years.
"For a start, a pound in three years time will be worth less than today, even at a modest rate of return. Why pay cash for a machine which has yet to earn a penny for the business and is quite capable of funding itself out of the income that it generates over time."
A key figure, says Mr Jaynes, is the cost of the investment to the business – a figure which remains unknown until the day the item is sold, not the day on which it is delivered. Recognising that price and cost are not the same can make a significant difference to sound business planning and profitable growth.
"Fixed cost finance really is a valuable tool for the progressive and efficient farm enterprise," points out Mr Jaynes. "When used to fund a new tractor, machine or vehicle, it produces a known figure for major capital expenditure for several years ahead, protecting the enterprise against volatility in the financial markets and against cashflow uncertainties.
Most finance companies are able also to tailor repayments precisely to match the net annual income of the business while reflecting a realistic period of use."
Although Mr Jaynes stresses that investment decisions should never be driven by tax considerations, the availability of a 50% first year capital allowance until 30 June 1998 is a welcome bonus for those who have carefully cost-justified new machinery or plant purchases.
"Experience has shown that investment success can be greatly enhanced by carefully investigating and costing those items which one believes can improve the business.
"For equipment with a medium to long-term payback period, opening an additional line of credit with a specialist finance house has the advantage of leaving existing bank facilities undisturbed to service the short-term variable and seasonal costs of the business."