FARM FINANCIAL MANAGEMENT
Farming is a lifestyle choice for many people. It is an existence that relies on their ability to live on the land. Knowledge of land use, animal breeding and rearing, working along with nature are all important aspects of farming. But to remain viable, it is equally important that a farmer is able to manage the farm as a business.
There are some aspects of business management that are universal to all successful enterprises. Financial management is one of these aspects. How should the business be set up? How will it be financed? What are the best options for investment, to keep the business going in the long run? These are all questions that must be asked, and answered to be successful as a business.
Financial management is not a one time decision, but an ongoing process. Annual budgeting, medium and long term plans, where to go for finance, what are the best investments for profit are things that must be decided and reviewed continually. Understanding what is involved in financial management is the first step.
Financial management is one of the most important aspects of any business. It is often not what you earn that is important, but how you manage it. Managing finances is an unavoidable task. Certain records must be kept and payments made, to comply with the law. Beyond these "essential" tasks, there are many other things that can be done to make a farm more profitable, and financially secure.
Any or all of the following are part of financial management: record keeping, taxation, budgeting, controlling spending, insurance, wills(probate), choosing sources of finance, evaluating performance, establishing better legal structures, etc.
Often a farmer may delegate many financial management tasks to a spouse, or an accountant. This approach has one major drawback. The farmer does NOT have as good an understanding of the business when they are not actively involved with the day to day financial management. This can result in poorer business decisions. The fact is, the more profitable farmer is most likely to be one actively involved in day to day financial management. It is wise to seek the advice of professionals, but participation in the final decisions made is essential.
RURAL FINANCE SOURCES
The local department of agriculture (ie. primary industries), may be the best source of advice on who or where to borrow money. Terms and conditions vary between institutions, and all alternatives should be compared before making a final decision. The main lending authorities are the major banks or specialist lending authorities (eg. Queensland Rural Development Corporation).
FINANCIAL TERMINOLOGY & RECORD KEEPING
Finance is basically interpreted as being able to manage money. The financial world along with all other industries have a language all of their own. We need to become aware of what all this jargon means to help us manage our money successfully.
The financial health of a company is based on its assets, liabilities and net worth. Assets are those things such as cash, property and equipment that a company has on hand. Current assets include money owed to the farmer/business, cash on hand and any stock or salable items in possession. For example, you may have a paddock of 20 cows ready for market, but have not yet found a buyer for them. They are therefore current assets. Fixed assets are things such as land, equipment and depreciation. They can all be converted into cash, but normally take a longer time to sell. Depreciation, while not a physical thing, is included as a fixed asset, as it is of value in terms of tax. The tax office will allow a certain amount of depreciation on fixed assets each year. (Depreciation is actually the wear and tear which causes a piece of equipment to decrease in value over the years.)
Liabilities are the opposite of assets, or those things which are owed. They are also separated as current and fixed liabilities. Current liabilities include accounts payable, or bills that must be paid and any expenses that have been incurred, but not yet billed for, such as electricity and telephone bills. Fixed liabilities are bills that must be paid over a number of years, such as a mortgage, called equity.
Net worth is the difference between assets and liabilities. It is any profit that the business has made. It may be held as cash or as ownership of all or part of the business.
When approaching a bank or other institution for a loan of money, or preparing records for tax purposes, the bank or accountant will often ask for a balance sheet, a budget and an income statement. The balance sheet is essentially a list of all assets, both current and fixed, a list of all fixed and current liabilities and the net worth of the company. The "balance" is that the total of the assets must equal the liabilities plus the net worth of the company.(Net worth is considered as part of the liability because, if the business stopped, that is the amount of profit the owner would take with them, therefore a liability to the business.)
An income statement is a list of all income and expenses incurred by a business, usually over a period of one year. It lists things such as gross sales, cost of goods sold, operating profit and income before and after tax. Gross refers to sales or income before expenses are taken out. Net refers to sales or income with expenses taken out. For example, net sales for a flock of sheep is equal to the amount received for the flock less the cost for feed, veterinary bills, transport to sale yard, commission, etc..
A budget is a plan or projection of what income and expenses the company will have over a period of time. Budgeting is a fairly subjective thing, especially in farming, where the weather can dictate if the year will be productive or not. An annual budget should be made each year, and reviewed every six months. At six months, the annual budget can be adjusted to reflect what is happening that year (ie. a bumper crop or a drought year). It is also ideal to have a 5 years and 10 to 20 year budget. This not only helps you to set goals for the business, but also gives any potential investors an idea of what it is they are investing in. For an existing business, the budget can be based on the average income and expenses for the past 3-5 years. For a new business, the first budget must be an educated guess, accounting for every possible expense that can be thought of.
Governments have to formulate economic policies which aim to benefit the whole community. Therefore they often intervene in the commercial world to impose conditions which are necessary to achieve those objectives. These include measures to improve the balance of payments, to reduce unemployment, and to control the supply of money and credit.
Banks charge fees for most services they provide, but the major proportion of a bank's profit comes from lending money. There are three ways banks can provide money:
1. A loan - a lump sum of money which can be used to purchase/reduce credit, etc.
2. An overdraft - allows the customer to draw cheques when he/she has insufficient money in his account to meet them.
3. Credit cards.
HOW BANKS CAN HELP YOU
Banks provide a broad range of services to the community.
1. A safe and convenient place for cash.
2. Executor and trustee services.
3. Cash for cheques.
4. Finance for goods.
5. Cash for bank customers.
6. Direct crediting facilities
7. Investment opportunities:
- Pass book savings (small interest)
- Banking systems (combination of saving accounts, cheque accounts, etc.)
- Stock deposits
- Government guaranteed bonds ‑ (e.g. 10 years/ interest free)
- Superannuation funds
- Traveller's cheques/ foreign currency
- Term deposits
- Bonds (e.g. for a baby or education).
Some banks can also provide payment for bills that clients receive. Financial counselling is also available!
Of course, a bank is not the only source of funds for a business. Private investors, other types of financial institutions and credit unions can also provide business loans. It is important to shop very carefully, and not base decisions solely on interest rates. For instance, you need to know the expectations of the lender should you fall behind in payments. A bank will often negotiate before calling in a loan, while a private investor or other source may choose to foreclose after just one missed payment. This is especially important in the farming sector, as there is not always a steady flow of income.
A lending institution has a base rate for lending to anyone for a business. An additional percentage is added to the base rate if the risk of failure is higher than normal (i.e. the higher the risk, the higher the rate of interest charged). It is normal for the trader to take out a mortgage over the assets offered as security for a loan.
Note that there are other charges which a borrower needs to pay, such as an establishment fee, mortgage insurance, stamp duty, personal insurance (e.g. to ensure that the loan is paid out in the case of death or disability).
In farming, as with any small business, the farmer is required not only to produce and sell, but also to act as marketeer, financial planner and buyer for the company. Many people like to be at the forefront with equipment and technology, but there are steps to be taken to ensure that the business overall remains productive and efficient.
Buying is a profession in itself. There is a certain level of skill involved in "wheeling and dealing", to get the best product at the best price possible.
To be an efficient buyer the following criteria should be considered before making any purchase:
a) Do you need it?
b) Can you afford it?
c) Is it the best time to buy?
d) Which is the cheapest? (best when buying in quantity)
e) Do you need the best quality?
f) How much should you buy?
g) Who offers the best terms (is it interest free?)
h) How will it affect productivity?
i) How long will it take to achieve a return on the investment made?
These guidelines can help you in attaining a good 'buy'. Believe it or not, we are a consumer orientated society and most of us are compulsive buyers. We are constantly being bombarded with advertising. This does affect us, just have a look at young children when an advertisement appears on the television, they are totally captivated. We are told, and its reinforced all the time, that unless we buy now prices will increase or stock will run out! Anxiety sets in and off we go straight to the retailer and buy. It is amazing afterwards how relieved we feel. Think before you buy - do you really need it!! Do you need it now?
At some point in time, nearly every business requires a loan of money. A business may require capital to start, or to make improvements or expansions that will make the business more profitable. Capital can be required during a very slow period of business, for instance if production is affected by flood or drought. A basic knowledge of the different areas of finance can not only be an avenue for receiving loans, but also gives ideas for investing personal funds. A bridging loan may be needed (e.g. Where almost all income is received at the one time when a crop is harvested; money may be needed to support the farm until that point in time).
Investing funds received in a good year can help to prepare for any subsequent poor years on the farm. Most farmers will automatically reinvest any profits into the business. However, there are other options for investment. One of the prime reasons for considering investing outside of the farm is to have a source of back-up funds that does not depend on the farm, the main source of income. Investment in the money market, stocks and bonds, and in other business can be an ideal way to "save for a rainy day". Most investments do have a minimum cost requirement, but most are fairly low, starting from around $500.
THE MONEY MARKET
The money market is the process of buying and selling money.It operates in the form of credit by way of an I O U basis or promises. Promises to pay interest, to repay loans, to provide cash etc. Every transaction requires a price to be paid in the form of interest. All those in the market are aiming to pay rates which are lower than the one they are currently receiving. Money market operators are looking at short term financing. Normally people who deal in the money market have large sums of money to invest. The Capital market provides the channels by which money is collected and made available for those who want to use it in business. For example, you may have one thousand dollars to invest, although this amount is too small to be of use to the company requiring capital. If you and several thousand people all invest an amount of one thousand dollars each you would end up with an incredible amount of money to invest into a company. What is required therefore is some organisation which is prepared to accept those small amounts, put them together and then invest a large sum. Such bodies are know as 'institutional investors'.
The money market can be an ideal place to invest business money, or personal investments.
The stock exchange is another place that business or personal investments can be made. Purchases can be made through a stock broker. Normally, there is a minimum amount of money to be invested, usually starting at around $500. The broker can provide advice on what stocks should be purchased, or you can nominate exactly what shares you would like to buy. There are two types of shares, speculative and blue chip. Speculative shares are normally riskier than blue chip. They are usually newly listed companies, or companies involved in ventures such oil drilling and gold mining. There is a higher rate of return on speculative shares, but there is also a greater risk of losing the money invested. Blue chip shares are relatively safe investments. The companies are very large and have a solid history. The shares are more expensive and the return lower, but the risk of losing money in such a venture is much lower than with speculative shares.
Of course, there are many investment opportunities such as purchasing rental properties or other businesses, term deposits with banks and bonds. The most important consideration when investing profits is to determine how quickly you need to have access to the funds. If you are investing to prepare for sudden events such as crop damage due to disease, floods or drought, then it is important that the money is easily available. Stocks and short term deposits are most suitable for these purposes, as the stocks can be cashed in at any time, and short term deposits can be withdrawn at the end of the term. If you are looking to gain an ongoing income, then business or rental property, which has a steady return is ideal or longer term deposits that pay interest in a regular period of time.
Financial planning is essential to provide security over the long term. Any effective financial planning will usually involve investing some money into things such as superannuation, annuities, or life insurance. It will also address issues such as medical insurance, life insurance, family law & wills, and the impact which such issues may have on the long term survival of a farm; perhaps over several generations.
The first step of financial planning is to determine the farm's long term goals. A "twenty year plan" will give the business a direction and something to plan for every year. Annual budgets and business decisions should be made with the long-term plans in mind.
Some things to consider include:
a) How soon can I realistically own the farm outright?
b) How large do I want the business to grow? (ie remain a family farm, grow to employ staff)
c) What will my core business be? (ie crops, livestock, tourism)
d) When do I plan to retire?
e) What will I do with the business when I retire?(ie pass on to family, sell, wind down the business)
A long term plan is not set in stone. As with all planning, it should be reviewed on a regular basis (eg. annually) and changed to accommodate personal as well as business changes. When a "twenty year" plan is complete, then medium term goals should be decided.
What needs to be achieved in the next five years such as:
a) What are my financial needs for the business?
b) What are my personal financial needs?
c) What equipment will I require?
d) What will I own and what will I still be paying for?
e) What stage of my "twenty year" plan will I be in?
Both the five and twenty year plans are basically goals for the business. They are designed to plan for your personal, business and financial needs on a general basis, as well as giving the business a direction to work to. The annual financial plan, however, is more of a working budget for the year. It takes into consideration both the medium and long term goals of the business while accounting for the day to day cost of running a business.
Some of the things included in the annual plan are:
a) What is my projected income for the year?
b) What are my projected costs? (i.e. supplies, equipment payments and repairs, upkeep of the property, wages, savings and investments, professional expenses such as solicitors and accountants fees, insurance, taxes)
c) What will I do in case of an "emergency"?
d) How will this help me to reach my long term goals?
The annual plan should be reviewed every six months. Any windfalls or unexpected expenses can then be factored in and the plan can be adjusted to reflect what is going on in real life.
Many people choose to farm because they want to get away from all of this "Office Work" of planning. But farming is a business and all successful businesses have some sort of plan in place. While it is often a difficult process at first, it will become a valuable tool in success in planning for the financial future of your farm, both on business and personal terms.
Before creating long, medium and short term plans, it is important to know and have some understanding of what financial avenues are available to prepare for retirement and for unexpected tragedy such as death and serious injury. Following are some savings requirements and options to prepare for these events.
The Australian Government is slowly trying to phase out old age pensions and they have implemented plans so that all workers have some form of personal superannuation. The government cannot afford to pay pensions to everyone that retires as we do not have the working population to support such a scheme (as our older population is growing older).
Putting it simply, superannuation is an insurance where the contributor receives either a lump sum payment or weekly/monthly payments to help them manage in their retirement years.To obtain this pay out, a set amount of money is paid into the superannuation fund per week by the contributor. Their employer is prescribed, by law, to also put in 5-6% of the contributor's gross salary for any employee earning $450 per month. The amount received depends on their health and years of employment. If death occurs before retirement age a reduced sum is available to the beneficiaries.
These are investments designed to provide a fixed sum payable at specified intervals over a designated period.
There are times when business on the farm is not as brisk as it should be. Capital is tied up and the flow of hard cash has dried up. Drought or flood are two good instances where due to unforeseen circumstances, a property loses production time. Whatever the reason for financial difficulty, it is well worth being aware of your social security rights. There are many instances where people from the land have hesitated before seeking this sort of help. DON'T. As an Australian taxpayer you are entitled to assistance during hardship. Why do we pay taxes in the first place? At least ask social security as you have nothing to lose and a lot to gain from programs you probably do not know about. If hardship persists, keep asking social security, as schemes may continually change, particularly with changes in government.
There are various types of life assurance policies. They will commonly pay out a sum of money upon the unforseen death (or disabling) of a person (e.g. the principal farm worker/manager). They are designed to provide financial support to allow the beneficiaries to adapt to the change in situation, without suffering (at the extreme -helping them avoid losing the family farm). There are also Income Protection Policies that pay a specified amount if the income earner is disabled.
FAMILY LAW AND WILLS
Divorce is an increasingly prevalent occurrence of modern society. It is necessary therefore to be aware of possible impacts that may be ruled upon in the event of divorce proceedings being brought before the family court. You should also be aware of de facto marriage arrangements and their consequences.
A will is a legal document. It indicates how you would like the distribution of your property to be handled should you die. If you die without leaving a will, you will be said to have died 'intestate', in which case your estate will be distributed evenly between your spouse and children according to a strict formula laid down by law.
Guidelines to making a will:
- The will must be in writing and signed by the person making the will.
- The will must be signed in front of two witnesses, who must also sign the will in front of the other two people signing the will.
- Witnesses must not be beneficiaries.
- Consult a solicitor or trust company for more detailed information.
- Divorce cancels any existing wills, so a new will is then required.
It is extremely important to keep accurate, clear and accessible records of all financial transactions which take place in a business. Different businesses have different types of book keeping systems. The options are very great. A balance must be struck though where you decide between a system which gives you the detail you require and one which doesn't take too much time to maintain.
Financial records are needed because:
- They help you manage your finances (e.g. you can make decisions about what something is likely to cost in the future by seeing what it cost in the past).
- They allow you to see whether your business is making a profit or loss, in the short & long term.
- They give you a basis upon which you can calculate what you will charge your customers.
- They allow you to prepare and submit you tax returns.
- They are legally required by government, especially if you have employees.
Records required include receipts for all money spent, a cash book, listing all money received and spent and a general ledger. The cash book is a daily expense and receipt record, while the ledger appoints those costs and receipts to specific "cost centres", allowing the accountant or taxation office to see how much is made or spent in a particular area. Most computer financial packages will allow you to key in the information and then put that information in the correct records.
SETTING UP BUSINESS
Deciding how to set up the farm as a business is often one of the most difficult aspects of the financial management. There are many decisions to be made, such as type of personal responsibility to be attached to the business, planning for the future and finding a fair and affordable source of money.
A farm, like any other type of business, can be set up as a sole proprietorship, a partnership or a company. As a sole proprietorship, the individual runs the business as part of their personal belongings. All income and assets belong to the individual, as well as all liabilities. Sole proprietorships are the easiest type of business to start. The down side is that, as a sole proprietor, there is no separation of business and personal assets, so if the business owes money it cannot pay, it can be taken from the individual. For instance, if the farm is run as a sole propriety, then a bank or money lender can expect things such as the family home to be put up for collateral.
A partnership is very similar to the sole proprietorship. The individuals involved are personally responsible for all liabilities, and if anything happens to one partner, the other remains responsible. However, the liability is shared between the people in the partnership, taking pressure from the individual. It is common for a farm to be run as a partnership between a husband and wife.
A company is a legal entity of its own. It is registered and responsible for its own assets and debts. There are many advantages to running a business as a company (or Proprietary Limited). These include the ability to separate personal belongings from business assets and protection of things such as the family home. However, companies are quite expensive to set up and the income that a company makes cannot automatically go to the owner (ie. you can't make your mortgage payment from company funds if you achieve a windfall).
The business setup chosen for the farm can affect the ability to receive funds from a variety of sources. A bank will more readily loan money to an individual if they own property such as a house or land for collateral. However, they tend to be more rigorous when considering loans to a new business with no assets. Once a business is running and profitable, it is not unusual for the bank to approach the business offering to loan money or may, by negotiation, reduce the interest rate under certain conditions.
There are other avenues for borrowing money. Your accountant will often have a list of people willing to invest their own money in a business. While the interest rate may be higher than that of a bank, an individual is often more willing to take on riskier propositions. Partnerships are also often a source of finance. One party may have the ideas and the capability to succeed in a business, while another has the finance available. Not all partnerships must be between only two people, or on a fifty/fifty basis. These details are often negotiable.
Outside of banks and private investors, obtain credit wherever possible. This is essentially a very short-term loan. Other options include purchase plans and leasing. While it is tempting to own as much of the business and equipment as possible, it is also a situation that attracts higher rates of tax.
Many farms are set up as family enterprises, with emphasis on continuing the business throughout the generations. One of the most tax effective ways of setting up a family business is to create a trust.
A trust consists of three parties; the creator of the trust, the trustees and the beneficiaries. The trustee's responsibility is to act on behalf of the beneficiaries, with the trustee owning legal interest in the property and the beneficiaries the equitable interest. A trust is different from a company in that it is not a separate entity from its owners, so the trustees are legally responsible for the trust. This includes liability for administering the trust, management of the trust, raising funds (apart from the initial funds, which are a gift from the creator) and paying tax on any income not passed on to the beneficiaries.
The beneficiaries of a trust are entitled to any interest as designated. The funds they receive can be used by the trustee to pay the expenses of the trust. They cannot interfere with the management of the trust, without taking legal action, and are personally liable for the income tax on any income they receive. There are no limits to the number of beneficiaries named.
It is advisable to consult both your Accountant and your Solicitor when considering setting up a trust. An Accountant would be most qualified to advise on what tax benefits the trust would be eligible for and how best to account for and distribute the money in the trust. A Solicitors is best suited to advise on the legal aspects of ownership, rights and responsibilities of those involved. As with most legal matters, the initial outlay can be quite costly, but the long range benefits can be worth the price. In Australia family trusts are not as great a tax saving as they have been in the past, due to changes in tax laws.
Paying tax is a necessary part of life. It pays for infrastructure, such as roads and bridges, government programmes and education for our children. The amount of tax paid each year is often different, due to changes in government, adjustment of tax laws and introduction of new taxes.
The best advice in dealing with tax is to suggest seeking professional advice. The farm already demands that you be expert in many fields; financial planning, marketing, animal husbandry and crops just to name a few. To try to be on top of the constant changes in tax law, on top of all other responsibilities, is asking a lot. Tax laws may change literally weekly, so it is important to use a tax professional who is able to keep up to date with such changes.
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