Farming businesses have seen considerable rises in working capital requirements that is, the amount of cash required to see your business through its various cycles whether it be growing crops or rearing livestock. To fund this you will often have to borrow money, most commonly, in the form of an overdraft. That overdraft will attract charges often in two forms, a fee paid at the time, monthly, quarterly or annually for having the overdraft and interest on the amount offered.
The following are some basic tips on how to keep your overdraft fees and charges down in what is likely to be a difficult market place with little opportunity to shop around.
Borrow the correct amount: Too often I have heard farmers say “How much can you lend me?” This is about the worst thing to say as it gives the impression of bad management. Understand how much money you need – do a cash flow – not for the Bank’s benefit, but for yours. Request the correct amount of borrowing. If you need less borrow less. Do not just take the overdraft that is automatically rolled over.
Note I recommend subscribing to Joey de Wit’s website to gain insight into cash flow management: What business all about: Cash Flow! (beehiiv.com)
Produce annual accounts quickly – preferably within 3 months of the year end. Yes this involves you being organized and employing an accountant that is equally organized. However, annual accounts are a snap-shot in time only. But they are used by Bank’s to quickly prove the ability to service (repay) debt. In my experience those businesses in the best position to negotiate better fees and interest rates are the ones with timely annual accounts. Furthermore, if you produce accounts later than 18 months after your year end you may find your Bank less likely to consider reducing charges as such information is rapidly historic and therefore cannot be used to argue that you have a good risk profile. Even if you have made a loss, provided you can explain why and how this will change it need not be a negative experience.
Borrow in the correct way: If you purchase a new tractor or machine do not be tempted to put it on the overdraft – machinery finance is usually cheaper and a better way to borrow. The same if you buy land – use an Agricultural mortgage. Remember, overdrafts are “repayable on demand” meaning in practice you could have it withdrawn within a month.
Run you bank account well: Keep your account within agreed limits and do not have items returned unpaid. Watch expiry dates and ensure you don’t lose an overdraft overnight because it has expired. The onus to monitor this is on you, NOT your bank.
Try the market: There is absolutely no reason not to talk to other Banks and consider changing banks. Get any agreements in writing and be clear what is required and the costs before deciding to change. Secured lending can mean one off solicitors and security fees when changing banks so you need to ensure it is worthwhile. Typically you need to get three to five years benefit with the new institution to warrant the cost of changing Banks.
Beware multi-banking it can make risk costs more expensive. With regards to using multiple lenders and how this can have detrimental effect on the ability to borrow please consider the following.
Depending upon the business Bank’s typically lend at 70% loan to value with overdrafts and loans. This percentage can go up and own depending upon the quality of the business and the Bank’s exposure in the market place. However, it is common for farming businesses to use more than one Bank. The typical
model will be that AMC lend money to buy land, they have a 1st charge and then another Bank will take a second charge on the same land to enable it to lend a working Capital overdraft. Using more than one Bank in this way can be a disadvantage if you have limited assets as security – consider the following example.
FARMER A has £1,000,000 farm as security he only uses Lloyds Bank. He has a mortgage of £600k and can have an overdraft of £100k thus 70% Loan to Value (LTV)
FARMER B has £1,000,000 farm as security. He has £600k mortgage (60%) LTV He also wants a working Capital overdraft with Barclays, whilst happy to take a second charge behind AMC the value of the security is much reduced because of the following:
£1million – 70% of this is £700k – AMC lend £600k – this means the available value of security to Barclays is £100k. 70% of 100k is £70k. By multibanking Farmer B has lost borrowing power. If Farmer B borrows more the risk cost will be greater incurring higher interest and fees.
Consider using your own cash: This is an obvious option that many business owners overlook. However, introduction of cash to the business should be done with reference to your accountant so that it is crystal clear that it is introduced capital. In the case of a limited Company a short minuted meeting clarifying this is prudent. When you take the cash out of the business in the future you do not wish it to count as income.
Be aware of what your business is classed as: Each business for banking and risk purposes has a BTA code or business code that identifies the type of business. If your business is coded incorrectly this can affect debt pricing. For example, a caravan site is usually a higher risk business than an arable farm. This can be problematic for a diversified farming business as the code is determined by the primary business activity and seasonal turnovers in agriculture can be artificially reduced from one financial year to another by overlapping trading cycles.
Secured vs unsecured debt: If you stay with the same Bank the giving of security is a significant one off cost that can have lifetime’s benefit in reduced borrowing and interest charges. However, over time the valuation of the security will become out of date (every three to five years) which may mean your security is undervalued. Yes a revaluation costs, but certainly on larger borrowings it will give your Bank greater flexibility to lend to you quickly and give you better rates.
However, giving of security may be a tie to that institution that you should give with appropriate prudence and not just as a pragmatic exercise.
Smaller overdrafts: As a rule of thumb unsecured debt below £25,000 given to a sole trader or partnership often has higher interest rates due to a combination of the Consumer Credit Act and the generally higher risk profile and costs of lower amounts of borrowing. I recommend asking your Bank about this – but do not recommend borrowing more money just for the sake of it, but a healthy understanding of the best way to borrow an amount is needed.
Finally the hardest item: Talk to your Bank. Nowadays this is somewhat hard to do. But any conversations you have I recommend that you ask for a summary by email of what has been discussed, agreed and next actions to “keep the ink red” in communication. The same if you speak to a potential new Bank.