Most farm businesses run on credit, in one form or another. Credit can come in a whole variety of formats, from the obvious such as farm business loan, overdrafts, hire purchase agreements, and leases, to the less obvious such as personal loans, PCP agreements, credit card, credit union debt, merchant credit, and outstanding debts to contractors, vets and other service providers.
Some forms of credit are cheap, and occasionally even free. For instance, some machinery dealers can offer 0% finance, where substantial deposits are paid, and the residual debt is paid over a short period, usually.
Other forms of credit can work out rather expensive, particularly credit card debt, with rates typically between 16% and 22%.
Merchant credit can also work out rather expensive, where interest is applied at 1%-1.5%, which may even be compounded, rather than interest simply going on the original debt balance, meaning interest rates can amount to from 12% to over 20% on an annualised basis.
Some merchants will offer a discount at the time of payment, and some may write off some of the interest applied, but purchasing on credit sometimes masks the fact that a better deal may have been available for payment on the day of purchase. Asking for a cash price, either at the point of purchase, or at the point of payment, where the invoice is being paid by the due date, could reduce your overall cost. Of course, if you rely on that merchant, contractor or other supplier’s credit, you may not be in a position to ask for a cash price, if you don’t have the funds to back up your intentions.
But replacing one form of debt with another can make business sense, especially where the overall effect is to both reduce the overall cost of credit, and secondarily obtain a cash discount.
Take for example, a farmer who obtains an overdraft at a rate of 6% (annualised) and uses the additional overdraft to purchase feed, which would otherwise be purchased on account. The farmer would have expected to pay off his merchant bill at the end of April following the sale of cattle. The feed merchant is willing to discount the feed purchase by €12 per tonne for payments on the day.
At a price of €250 per ton, the saving works out at an annualised rate of near 50%.
If the farmer repeated the exercise and was able to save €12 per ton every five weeks, having initially borrowed €250 from the bank, then recycling that cash-flow generated by obtaining banking credit would save the farmer €120 in feed costs (for 10 purchases of feed throughout the year, at €12 saving per purchase) — at a cost of credit of €15 in bank interest.
Taking the above example and multiplying up by the amount of purchases typically made by farmers on credit (be it credit from merchants or other suppliers or contractors), and the savings can amount to thousands.
On the flip side, having credit when no credit is needed is a cost to a business.
Typically, farmers will have surplus funds in their account at some times of the year, and may be in deficit at other times.
Farmers may have term loans, or stocking loans, with interest rates based on the amount credit forwarded, yet a farmer with positive funds in the current account will typically get no interest.
Where the duration of term over which funds are borrowed is relatively low, overdraft and credit line facilities can work out less expensive that term loans or stocking loans, where interest is payable for the full duration of the loan.
Say, for instance, a farmer has a choice of obtaining an overdraft at 6.5%, or a stocking loan at 5%. The stocking loan is repayable at 12 months.
During the year, the farmer has surplus funds in the farm account for 250 days of the year, and accesses the overdraft for 115 days of the year.
The overdraft facility will work out cheaper than the stocking loan, because interest is only applied for the term the funds are borrowed, even though the headline APR rates are higher.
Giving attention to how your farm business uses formal and informal credit, and changing the manner of credit, can result in less costs and more profit.
Each person should obtain professional advice relevant to their own circumstances.