Are you managing your working capital?

There has been cause for optimism in farming cash flows over recent months. A long-awaited milk price increase, strong market conditions in most sectors, and payment of the first instalment of this year’s Basic Payment Scheme, will have all helped to improve financial positions. However, these inflows will have only ‘steadied the ship’ for many businesses, with a number of farms still reeling from the burden of increased fuel and fertiliser costs, and general inflation across the industry. The drought in July and August means many livestock farms will go into the winter with depleted silage stocks, and shortages will only compound the financial pressures threatened by inflation.

Technically speaking, working capital is a business’ current assets less its current liabilities. In simple terms, a business relies on its short-term assets like cash, debtors and stock to cover the cost of its creditors, loan repayments and asset finance. Some farms’ working capital will be deteriorating, as increased costs erode cash reserves and increase overdraft balances, but even those businesses with strong cash flows should appreciate that their working capital will need to increase as inflation continues to drive up costs.

While creditors are rising, fixed payments for loans and other borrowings will continue unless action is taken. And if money is being depleted, any value being tied up in assets that are not pulling their weight in the business, would likely be better converted into cash.

In recent years, many farms will have funded expansion using loan financing with optimistically short repayment terms. While it may have been feasible to repay debt over 10 – 15 years while inflation was modest and cash flow was more predictable, it will likely be a good idea to now consider whether longer terms of 15 – 20 years are more appropriate. There is no shame in approaching your lender to renegotiate repayment terms and most banks will be open to discussion, because ultimately it is in their interest as much as yours to see loans being repaid sustainably. Although many businesses fear the cost of rising interest rates and will want to repay debt as quickly as possible, keeping loans on flexible terms should allow more capital to be repaid as and when cash flow allows.

If you have not already taken advantage of some of the repayment holidays offered under the Bounce Back Loan Scheme, now may be a good time to consider this.

When considering what action may be needed, it is essential to look ahead to where you are likely to be in the months to come. The easiest way to tackle this is to forecast cash flow, by mapping out the business’ income and input costs on a month-by-month basis for the foreseeable future. Do not forget that this winter will see only half a year’s Basic Payment Scheme income being received, and make sure your accountant has given you plenty of warning of any tax liabilities that may be due in January.

If you have variable rate borrowings, remember to take account of the fact that rising interest rates will increase the cost of servicing this debt. Most importantly, do not underestimate the impact of inflation on your cash flow forecast, as input costs are likely to continue to increase in the next 12 months. If the numbers do not add up and you think additional finance (such as an increased overdraft) will be needed, begin the discussion with lenders as early as possible.

Ultimately, it is the strength of a business’ working capital, rather than its profitability or overall asset position, that will dictate how smoothly that business will run in the year to come.

If you would like to discuss your working capital options, contact your Old Mill adviser or click here…