The property market is facing a liquidity crisis, but farming has a funding problem of different making, as George Chichester of Strutt & Parker’s Newbury office explains.

Sale prices for most farming commodities have shot up over the past year – particularly for arable crops but also now for beef and sheep meat. But, following rapidly behind, has now come a large rise in input costs too, particularly for fuel and fertiliser.

Cash flow timing has also been affected. Historically, farming inputs were bought and paid for as needed, and subsidy value was included in the sale price of the crop and thus received when the crop was sold. The basis of subsidy payments changed in 2005, and the decoupled payment is now made rather later than before – indeed some farmers are still waiting for their payment for 2007, halfway through 2008. Nitrogen fertiliser – one of the main inputs – is often purchased months ahead of requirement, in order to secure a better price and a guarantee of delivery.

The combination of these factors means that, whilst output is up, costs are also up and so is the demand for working capital to fund the farming cycle.

Take, for example, a 1,000 acre all-arable farm. Direct costs might have risen from approx £100 to £175/acre. In addition, the main fixed costs of machinery and labour provision might have increased by £50/acre. Adjusting for cash flow changes and adding for inflationary increases in other overheads, and a likely rent rise too, such a farm might well be facing an increase in its peak working capital requirement of £250,000. How is such a sum to be financed?

For an arable farm which has sold and will sell its grain to good advantage for the 2007 and 2008 harvests, the accounts for these 2 years will show some fantastic profits. Some of this might be needed to fund necessary investment in machinery and equipment. Some might fund a well needed holiday or future pension provision. Some might be retained in the business account. So this is the first option for funding the increase in working capital requirements of the business. However, income tax will be payable. If the full extent of the additional working capital requirement is to be met, this would equate to a retained profit of £375,000 for my 1,000 acre example.

The second option is to arrange an increased overdraft facility. Whilst banks have been nervous of mortgage funding for purchase of residential or commercial property, in our experience it has been “business as usual” for agricultural property, and banks have generally been willing to extend overdraft facilities on similar terms to those prevailing. This applies particularly to owner-occupied farms with a good record and low present liabilities.

The third option would be to take out a fixed rate loan in order to inject capital into the current account. Ultimately, the impact of this is not dissimilar to an overdraft, but a loan is normally repayable in annual instalments. However it provides the flexibility to lock in to a medium or long term interest rate for those who think that interest rates might rise in the future. It also provides some certainty, as a bank loan is not repayable except as agreed at the outset, whereas an overdraft can be called in.

Generally speaking, cautions George, investment in a farming business does not match investment in a bank deposit account, and therefore it is not viable for a high proportion of working capital requirements to be borrowed. Rather, investment in farming enables equity to be built up in the proprietor’s business and provides a quality and location of work place which can seldom be matched by an office. Consequently, Strutt & Parker’s advice is that at least a proportion of the windfall profits which will derive from the high prices but historical costs relating to the 2007 and 2008 harvests (for arable farmers) should be retained within the business, to fund the ongoing and future needs and development of the business in the years ahead.