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Farming is a volatile business and constant improvements are necessary to keep your farm up to date and to make life easier. The purchase of a tractor for spring and summer work or putting in extra slurry storage are two examples which may cross a lot of farmers’ minds but it is important to weigh up your options financially first before making these decisions.
Purchasing the tractor outright or financing it, paying for the extra slurry storage out of cash flow or approaching a financial institute for the capital work are important decisions to make and the more information you have readily available to you, the better.
Debt and financial information
Often phone calls come from accountants in early January requesting financial documents from the previous year but very few farmers actually send it in until almost the summertime or later.
Of course, pressure is on in early January with animals being indoors and farmers ramping up for a busy calving or lambing period or trying to get stock back out in the fields. Gathering information for your accountant can be down the list but it is an important job to prioritise.
Invoices, bank statements, co-op statements, milk/mart receipts are the number one priority when gathering documents to give you an outlook as to where you stand financially. Having this information with your accountant in early January can allow them to put together your accounts within a couple of weeks, thereby, giving you a good understanding of how the previous year went and whether you can afford to start a new project this year or hold off for another year.
Interpreting the accounts
Interpreting the financial statements can sometimes be difficult as there is a lot in these accounts – but a few simple rules to follow can make this easier.
The profit figure is how much your farm made before any capital investment, drawings and loan repayments were made in the previous year (see example below).
Example
Farm profit » €50,000
Loan repayments » €5,000
Capital expenditure » €5,000
Drawings » €30,000
Total expenditure » €40,000
Total free cash flow » €10,000 (€50,000 - €40,000)
In simple terms, this is the money you have spare to do extra capital work, save for yourself or to invest, if you want to go that route.
With regards to the possible purchase of a tractor or extra slurry storage in the example, this figure highlights how much you can spend based on last year’s figures, if you expect this year to go much the same. It could be hard to do either of these with €10,000 depending on the size of the tractor or slurry storage, so it may be worthwhile exploring the finance option.
If €10,000 is your free cash flow at year end, you may assume this is your annual repayment capacity for a new loan. However, due to financial institutions taking precautions and stress testing for situations such as a financial downturn, this figure will be discounted back and your repayment capacity could reduce to €7,000.
For a tractor purchase, your options are a lease or a hire purchase. If you enter a finance lease, the general term of this is five years and the value of the lease payments are written off over five years for tax purposes, resulting in a lower tax bill compared to a hire purchase option. With this option, the tax benefits are over eight years because you will own the tractor, so it is included in your balance sheet resulting in capital allowances being used against your tax bill.
If you are purchasing a tractor and your repayment capacity is €7,000, you could afford to borrow circa €29,000 over five years at an interest rate of 6%.
Term loan
When it comes to increasing your slurry storage, this can often be a more expensive job and may cost more than €10,000 to do. For this reason, it would be worth considering a financial institute and requesting a term loan.
Term loans are longer terms and often more favourable interest rates but there are limits on the term and value you can borrow unsecured.
A secured loan is a loan where land or buildings are put against a loan as collateral damage, in case you cannot afford the repayments anymore.
For smaller capital expenditure jobs, it is usually easier to go for an unsecured loan. If the slurry storage extension is going to cost €50,000 and you have a discounted repayment capacity of €7,000, you could afford to borrow the €50,000 over 10 years at an interest rate of 5%. The loan repayments would be €6,475 annually.
There are a lot of other areas that should be considered when making financial decisions, such as the outlook for the year ahead, which is why drawing up a budget is important when considering work such as the above examples.
Some farmers like to avoid financial debt so it may be more beneficial to wait another few years before making the investments or else start the slurry extension and do it in stages over a couple of years out of cash flow.
Farming changes every year and your profit could double this year or it could halve, so it is always important to have a buffer for your own mental comfort and savings as back up.
Before making investments it might be worthwhile to build up a rainy day fund as we all know capital projects on the farm nearly always have overruns.
Jerry O’Neill is an ACCA qualified accountant working as an Agricultural Consultant with Brady Group Agricultural Consultants and Land Agents
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