Survival instincts
Survival instincts
Restructuring is the route to better profit – and the options are many and varied. But where to begin? Peter Read seeks professional advice
MASSIVE falls in income – between 45 and 50% – over the past four years are forcing a dramatic change on arable farms. Richard Warburton, an agricultural business consultant with Bidwells, which manages between 25,000 and 30,000 acres across the eastern regions, is convinced that many arable businesses will have to restructure – just to survive.
Benchmarking is often used as a tool to illustrate how well businesses are performing, but Mr Warburton urges caution with its use. "Each business has its own eccentricities and these always need to be at the forefront of an advisers mind. And then there are regional differences: what is right for East Anglia may be disastrous for the Scottish borders. Also, simply telling farmers that their costs are too high does not necessarily help them."
When advising on a change, Mr Warburton starts off by analysing financial records – especially the level of borrowing. "I will then tease out the objectives of the farmer. What I need to know is: his lifestyle; how involved he wishes to be in the business; how he feels about making changes in the labour force, including redundancy; together with his other business interests."
The first consideration is whether sufficient improvement can be made to the existing structure. This means assessing the business labour and machinery. Is the labour committed, flexible and skilful? Is it full-time or casual? Is there a high standard of management and what are its capabilities? He will consider whether the machinery arrangement is suitable for the holding and resourced appropriately, ie owned, hired or contracted.
"To make changes often involves a very detailed logistics exercise – carried out with the farmer – looking at the work rate and the days available for operations. With a combinable crop business you are not necessarily busy all the year round." He often advises replacing owned machinery with hired. "If you need a 120hp tractor for eight weeks of the year and can hire for £3,200 it is more cost-efficient than owning it." Mr Warburton also suggests reducing machinery by doing 24-hour shifts.
On reducing fixed costs he adds: "Historically, survey data has shown smaller businesses being just as profitable as larger businesses because the larger businesses have not taken advantage of their economy of scale and reduced their fixed costs. However, this is changing".
He will then look at the suitability of the enterprise mix and marketing of produce, particularly crucial for root crops. Mr Warburton says that there has to be an increased awareness of the macro-economics. "Since Agenda 2000, reduced intervention support levels have meant greater volatility of prices, and this will continue."
What happens if improving performance within the existing business structure does not achieve the objectives?
"One possibility is to use stubble-to-stubble contractors, paying in the range of £75/acre to £95/acre. You have to be careful: the arrangement does not financially encourage the contractors to do a good job, and there are good and bad contractors." Nevertheless independence and control of the land is retained.
An alternative is spreading fixed costs by farming more land – as a contractor, on a farm business tenancy (FBT) or perhaps through a joint venture arrangement.
Demand
With FBTs and contract farming arrangements, be aware that demand still outstrips supply, keeping rents and prior charges high, warns Mr Warburton. "If a farmer of 1,200 acres takes on an extra 300 acres he will have an extra marginal fixed cost of, say, £60/acre on each of those 300 acres. With a gross margin of £200/acre he will have a benefit of £140/acre on the extra land but might then have to pay 75% of this – £105/acre – as rent or prior charge." While rents and prior charges have adjusted slightly to reflect the decline in incomes it is not by much – 10 to 15% reduction since 1997.
Two further problems with the idea of expansion are that firstly, suitable nearby land might simply be unavailable, and secondly, there is a limit to how much extra land can be taken on at marginal cost, as ultimately more labour and machinery will be needed.
"Many businesses that took on land before 1997 have found the expansion unprofitable."
Letting someone else act as contractor in a contract farming agreement is often the most profitable option. "It is, however, seen by some as abdicating their farming to someone else – which they find unpalatable. It is also difficult to return to in-hand farming because of the cost of re-equipping with machinery."
Joint ventures, in their various forms, are another way of achieving benefits from economies of scale. "Their advantage is that the benefit is not given away as rent. This is why joint ventures are generating a lot of interest at the moment."
Complex tax issues come into play when considering the different agreements.
With contract farming the income is treated as earned (Schedule D). But with an FBT the income would be classified as let (Schedule A) as the owner is no longer a trading farmer.
Mr Warburton gives a summary of the three important tax disadvantages of receiving let income:
• Prevented from accessing rollover relief from capital gains tax in the event of a sale
• Cannot benefit from inheritance tax agricultural property relief (APR) on the main farmhouse, if it is occupied in conjunction with the farming of the land
• Unable to offset any proportion of expenditure against income
Specialist tax advice is particularly important with joint ventures. "They can be structured in a number of different ways, such as partnerships or limited companies. Each structure will be different from a tax point of view: issues include using capital allowances and making best uses of losses."
Finally, there are the more dramatic options of buying more land or selling-up. "Buying up neighbouring land might improve profitability but this would not justify the capital outlay," he says. "Agriculture land has not decreased in value to reflect the reduction in farm incomes. This is due in part to its tight supply together with non-agricultural investment."
Remember that any restructuring must be very carefully thought out. "If youre going to make a major lifetime change to your business make sure you get it right."
A bad decision can be extremely costly. "Bidwells earns more fees from sorting out a thoughtless restructure than from planning a restructure," says Mr Warburton.