Major increases in crop prices will probably offset the decline in Basic Payment Scheme income for most arable farmers this coming year. Or will they? A new era of volatility makes it ever more worthwhile to have an accurate picture of costs and income, as Bidwells’ Matthew Page discovers.
Whilst most farmers are currently focused on finishing autumn drilling work and making the most of this weather, few of them will have given much thought to budgeting and cashflows. The reassurance of feed wheat at £190/t and oilseed rape nearing £500/t is a comfortable reason to postpone such tasks until the wet days of winter confine one to the farm office. The declining Basic Payment Scheme (BPS) income over the next few years means that farmers’ exposure to volatility is greater than ever, and the table below demonstrates how the value of a 500-acre farm’s BPS cheque will be eroded up to 2024, after which further deductions are unknown (although BPS will be completely removed by 2028). This is why farmers should have a total understanding of their cashflow and budgeting.
Farm budgets shouldn’t be written and then discarded, especially when input costs can suddenly rise (look at nitrogen fertiliser prices this autumn) or if more inputs were needed than originally expected, for example, if an unplanned T0 was used. If this asset is used to its full potential, it is an ever-changing and evolving database of information, often starting with well-educated best guesses and then being refined.
It is important to be realistic about expected income and costs when forming a budget; this means not over-stretching your estimations of grain price and yield, particularly if you have no risk management measures to fall back on. Otherwise, you may find that you are overstretching yourself, which can cause financial difficulties down the line – usually in cash flow.
As a firm, the budgets we prepare tend to have four elements: a gross margin analysis of the individual crops and enterprises, an estimation of what the eventual profit and loss account will look like; crucially, a 12-month forecast of cash flow – and for those farms on contract farming agreements, a breakdown of the expected earnings for the farmer and contractor.
Each element of the budget informs us about how we expect the business to perform. For example, the gross margins show us the relative contributions to profit from different crops or activities; whereas the profit and loss budget gives a big picture view on the ultimate outcome of all the work of the year.
When constructing a budget, we start with the gross margin exercise. Yields in tonnes per hectare always seems a sensible and traditional starting point. It is often tempting to revise these yields on what has happened recently, however, basing your assumptions on (at least) a five-year average is a far better option. Next, you need to choose a price to attribute to the crop. This can be tricky especially with the volatility of late in the cereals market. It is often best practice to be slightly bearish in your estimations and err on the sides of caution. This is why going back to the budget and making amendments through the year is so important.
For example, if you commit to a wheat contract you can then come back to the budget and commit that proportion of wheat to a set price in the budget, which gives you a more informed picture of how you are performing. We call this revision to the budget re-forecasting. This also allows you to see how you are comparing to your initial calculations which you made at the start of the year. It can also alert you to possible shortfalls in your enterprises.
Once the gross margin budget is complete it is very easy to add the different gross margins together to start the basis of the profit and loss element, which gives a picture of the overall business enterprise profitability. Its format also makes for an easier transition into a proper annual management account.
At Bidwells we like this profit and loss element of the budget because it becomes uniform in appearance with our profit forecasts and management accounts which are prepared after harvest and after the year-end, respectively. It also allows you to identify your overall net return – particularly if you have to split or share that in some way.
A projected cashflow is also essential. A well-constructed cash flow will allow you to see where the pinch points in the business are and allow you to come up with a process of how to overcome these pinch points. It is also worth remembering that when the cash runs out, the business will come to a halt, even if the business is profitable overall.
Contractors will know only too well how important it is to manage their cash flow and the immense pressure that can be put on a business from unpaid bills.
Arable cashflow patterns tend to have pressure build-ups in the spring, when income from crop sales may be exhausted, and spring fertiliser and pesticide costs are due, alongside the constant requirement to fund the fixed costs. Usually, the peak cash drawdown occurs in August or September and this is where overdrafts become stretched before early crop income is realised. We are often perplexed as to why some major costs – like combine payments – are arranged to be paid at this point. Providing sufficient working capital is a critical part of cash management, whether that is funded through an overdraft or own funds.
Having a total understanding of a business cash position requires more than just looking at the overdraft each month. It is also important to look at the value of the purchase ledger account, which is the value in supplier invoices and unpaid bills at that point in time, along with the value of the sales ledger control account, which are sales the business has invoiced for, but which it has not yet received income. We report this information to clients usually on a monthly basis.
The removal of BPS will mean that many farmers will have to consider how they arrange income. The December payment of BPS has helped to buffer spring input costs or cover overheads once crop sales are completed. Now with the decline of BPS, it may be necessary to consider selling grain to generate cash, something avoidable in the past. This may mean that you have to accept a slightly lower price than what you could achieve if you held onto the grain for sale later in the year. But sometimes it is more important to have the potential cost realised as cash in the bank, as opposed to a crop in a shed. There is a delicate balancing act to play between getting the best price for your product and having enough cash in the bank to be able to fund continuing operations.
It will also be more important than ever to be purchasing inputs at the best price. For example, if the cash flow allows it would be advisable to buy Triazoles now rather than waiting until the spring as the market suggests that the prices for these products will progress next spring. We have all seen how important looking ahead at the market is this year with fertiliser prices and it has shown how vulnerable we are as an industry to a sudden rise in the cost of inputs.
So, although sitting and creating a budget can often seem an ominous task and possibly a boring one too, but it is always time well spent.
Matthew Page is a graduate agriculture consultant with Bidwells. www.bidwells.co.uk