Making a Profit is only half the story

 – By Mark Shepheard, Director for farm advisers, Laurence Gould Partnership Ltd.

Following a period of low farm commodity prices and poor profitability, prices now appear to have started to increase to levels approaching or exceeding generally accepted breakeven levels. For many these increases cannot come soon enough with cash flow tight and in many cases increasing bank borrowing.mark

Making a profit is important but over the last 25 years, it has become clear that how profits are spent is equally important, especially following a period of low profitability.

Understanding how high your profit needs to be to cover the capital requirements and maintain a financial balance is an important starting point with many farmers surprised at how much profit they need to generate in order to prevent the bank position deteriorating. The profit needs to be sufficient to repay bank and HP borrowing, invest in machinery and buildings and cover private drawings and taxation. There is a tendency for farmers to overspend profits – being too optimistic about how much debt repayment, livestock number increase and capital investment can be funded within a short time period.

Preparing a realistic budget for the next twelve months to include a statement of profit, built up from the physical performance of the farm, and a flow of funds statement, detailing debt repayment, capital and private expenditure will:

  • Allow the balance between expected profit and the capital requirements to be judged
  • Provide a useful framework against which changes in prices can be assessed
  • Allow all areas of production and costs to be challenged
  • Allow decisions to make changes to be made with greater confidence
  • Allow targets to be set for making improvements in technical and financial performance
  • Allow alternatives to the current farming system to be judged
  • Allow informed discussions with the bank manager
  • Allow progress through the year to be monitored to ensure progress is made

Most farming businesses have a requirement to reinvest and there is always a seemingly endless list of potential projects requiring cash.

Capital expenditure requires prioritising and getting the timing and scale right. Farming will continue to face volatile prices and uncertainty. History shows us that with an increase in farm commodity prices:

  • Farmers spending increases to catch up on a period of exceptional cost cutting and under investment
  • Input prices rise
  • Commodity prices will fall again at some point

Any increase in farm profits could be short-lived and following a period of higher commodity prices it is especially important to be able to look back and be content that profits were spent in a controlled way.

The key is to be in control and maintain a business where profits and capital expenditure are in balance, with profits spent to place the business in a stronger position without over committing to repayments for the future. You can only spend your profits once – consider your options carefully!

Mark Shepheard is director for farm advisers, Laurence Gould Partnership LimitedLaurence Gould has been providing advice to farmers and rural businesses for over 50 years. From their South West office the team of seven consultants help farmers focus on practical solutions to increase profit, invest in farming and diversification projects and assist with determining business direction. Laurence Gould’s consultants are happy to meet any farmer for an initial discussion, free of charge, to discuss their business.

Posted in ARA.