Keeping on top of borrowing

The recent publication of Scottish agricultural businesses’ bank borrowing showed that at the end of May total farm bank debt amounted to £2.32 billion. This figure has been rising every year for the past eight years and the year-onyear increase was 5%. As UK inflation is running at around 2.9% this shows there is an increase in debt in real terms over the past 12 months.

These headline figures do not look good but of course within the overall picture there will be farm businesses increasing borrowing for very different reasons.

One reason for increased borrowing which affects most businesses is that the cost of inputs whether that be seed, fertilisers, breeding stock or machinery have all risen over the past year and a lot of this is due to the fall in value of sterling against the euro.

This currency movement has been good for farm produce prices but does mean that in general working capital requirements, or the amount of cash tied up in production, has increased.

Earlier payment of 2016 farm support monies would greatly help to alleviate the need for farms to seek further increases in borrowing.

When we are going over accounts with farmers one of the most common questions that arises is if they are making a profit, why are the bank borrowings not reducing.

With most farms operating as partnerships or sole traders rather than companies then the net profit is not the bottom line as far as cash expenditure goes. The net profit has to be high enough to also cover personal drawings and tax to leave the business with a surplus for the year and this will be reflected in the net assets of the business (or total at the bottom of the balance sheet) growing year on year.

Even if this figure does show the business has grown, the cash position can still deteriorate due to other outgoings such as loan or HP repayments and expenditure on fixed assets such as land, buildings and machinery which is in excess of the annual depreciation figure.

Alternatively, if you spend less on machinery for example than your depreciation charge your cash position will be better but does this mean that the assets of the business are being run down?

In the short term most businesses can cope with periods where, although profitable, their cashflow is negative and banks will generally be supportive where the business can explain why there is a deficit on the cashflow, why this has arisen and how it is expected to reverse in the future.

This situation often arises in businesses that are investing and growing for the future and will see the benefits of that investment coming through when the profits grow to cover the additional borrowings they have taken on and ideally the farmer should have in place financial plans which demonstrate that some period of negative cashflow was not unexpected.

Likewise businesses showing small profits or losses can survive where they are able to cut back on cash expenditure but eventually some investment will be required to at least maintain the assets of the business.

Given the historically low interest rates on borrowing then increased borrowing on an interest only basis has not been too hard for most businesses to deal with, however the Bank of England’s recent announcements seem to have increased the likelihood of interest rate rises in the not too distant future.

Since the credit crunch and low interest rates, borrowers on variable rate loans have benefited most, whereas those on fixed rate loans have generally being paying interest at higher rates.

Knowing what is a good rate to fix future borrowing at is forecasting the future, and is like any forward contract such as selling crops in advance.

When considering a fixed rate one of the main criteria is to set a rate that you expect to be comfortable with the payments, rather than trying to spot when is exactly the right time to do that.

If you can predict the future then you will not need to be a borrower for very long.

Picture: PA. Farm bank debt has been rising every year for the past eight years.