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Key Lessons from Past Farm Investment Experiences
Liam Phelan, AIB Agri Advisor urges a planned and prudent approach to farm investment.
One of the last periods of significant on-farm investment occurred from 2006 to 2008, supported by the grant aid provided under the Farm Waste Management Scheme. It is estimated that gross on-farm investment was over €4.5 billion in that period, peaking at €2 billion in 2008. In addition to the investment undertaken from cash flow and farmers’ own resources, lending to the sector reached record levels at this time.
The difficulty for many farmers who invested at that time was that this period of significant investment was quickly followed by a relatively short period of depressed commodity prices, poor weather and a somewhat lengthier period of high costs. This led to a dramatic reduction in farm profitability in 2009 (farm incomes fell by 41% between 2007 and 2009) and many farmers experienced a very difficult period with cash flow stress common on many farms.
There are some lessons which we can learn from this period, which may be useful for farmers considering future farm investment.
Don’t Base Decisions on One Good or Bad Year
Many farmers undertook investment supported by strong average farm incomes in 2007 and the availability of grant assistance. Decisions to invest in the farm should never be made based only on a good year or on high performance expectations but rather on the longer term likely performance and actual capability of the farm. Our advice to customers is to take a multi-annual view and examine the performance of the farm over the previous three to five years taking account of variations in the actual outcome and profitability.
Fully Cost Any Investment
Farm investments often take longer to complete and cost more than originally planned. This was the case in 2007 and 2008 when the cost of steel and concrete increased considerably and added to on-farm development costs. Before undertaking any farm development, it is important to cost the investment fully and it is prudent to include a contingency cost of around 10-20% in all plans. To get a realistic idea of the potential cost involved, and to learn from the experiences of others, it is good advice to take the time to visit similar projects and get quotations from a number of reputable suppliers.
Understand Impact on Cash Flow
During periods of capital investment, good cash flow management is key. While many farm investments will contribute to increased profitability in the longer term, they can place immediate pressure on the farm current account. This is particularly the case where some of the investment is funded from cash flow. Where farm investment is carried out from cash flow, it can compromise the ability of the farm to withstand a cyclical or unexpected downturn in the sector and a period of low margin income. Many of the difficulties in 2009 were compounded by the fact that savings on many farms had been depleted to support farm development in the previous years. Before undertaking any farm investment, it is desirable to complete a cash flow forecast to understand the effect of the investment on the cash flow of the farm.
Structure Loans Correctly
Ideally, a loan should be structured to match the useful life of the asset being financed. It is important not to put undue pressure on farm cash flow by seeking to repay a loan in an unrealistic timeframe which comes from trying to finance capital expenditure items over too short a period. The shorter the loan period, the higher will be the immediate repayment requirements.
Build a Buffer Fund
Volatility has become a feature of the sector in recent years and it is important that farms can rebound quickly from periods of low returns. During periods of higher returns, farmers should seek to build a buffer which can be utilised during periods of cash flow pressure and low income returns. This buffer can take different forms, e.g. building a cash reserve, reducing creditors, improving soil fertility and / or forward purchasing of inputs. Those farmers who undertake significant investment tend to be more exposed to the effects of volatility as savings may be depleted and bank repayments tend to be higher. In 2009, a period of low market returns and higher costs coincided with higher bank repayments on many farms.
It is important that this investment is carried out in a planned and sustainable manner and that adequate time and resources are devoted to the planning process. The increased level of volatility witnessed on Irish farms in recent years has highlighted the importance of financial planning when undertaking farm investment. It is likely that this level of volatility will continue into the future and it is important that all farm businesses are able to take advantage of the good years, while weathering periods of reduced incomes and low market returns. It is important that we learn from the past and ensure that any future farm investment does not compromise the ability of the business to survive and prosper in the longer term.
Planning Farm Investment?
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