Funding a farm building project - the options

Kevin Connolly

Generally most on-farm investments can be classified into one of the following categories:

• Investments that are necessary for the farm to remain in business
• Investments that will improve output or reduce costs thereby improving profitability
• Investments that will make running the business easier due to improved labour efficiency
• Investments that will allow new opportunities to be availed of i.e. a new enterprise

Costing the investment

The cost of any investment is two-fold – the initial capital cost to put the asset on the ground and the running costs, after the asset is up-and-running.

Assessing the capital cost

The major costs in a farm building investment are labour and materials. However there are also other associated pre-construction costs to be considered such as the fee for preparation of drawings, the grant application preparation fee and the planning application fee, if applicable. Once you have decided on the type, size and specification of the building and have had plans drawn up you can then estimate the cost of turning this plan into reality. Teagasc have standard costings available to allow most farm building investments to be roughly costed. However to get a realistic idea of the potential cost of the investment it is important to get quotes from a number of building contractors. A word of advice in relation to getting quotes- it is important to enclose, in addition to the building plans, a detailed specification of any extra work (such as extra concrete aprons or extra gates) required over and above the main building work. This has two benefits – it reduces the risk of having to pay over the odds for ‘extras’ after the main work is completed and it also allows you to easily compare quotes as you can tell each contractor to quote for exactly what is specified and no more. Work with your adviser to have the specification of your building as tight as possible before you go looking for quotes. If you intend supplying some of the labour, machinery or materials for the build then you should also specify this before getting quotes.

Running Costs

Once the new facility is in place there may be extra running costs involved in operating it such as higher electricity bills due to newly installed automatic scrapers, higher straw demand due to new loose lying area etc. Try and get a handle on these costs as far as possible. Alternatively there may be cost savings due to better building design, better layout of tanks for improved agitation giving a saving in time and diesel for agitation.

Sources of funds for the building development

Once the estimated cost of the building is determined the net cost, which is the gross cost less any grant received can then be calculated. This net cost will have to be financed from a number of possible sources. Also keep in mind that there will also be a lag period between paying for the building work and receiving the grant to cover part of the cost. In this case short-term bridging finance may need to be arranged to cover the total building cost until the grant payment comes through.

1. Farm Cash flow or business cash deposits

   Developments which are funded from this source are likely to be small in scale.

   This source of funding also has a cost which should not be overlooked. The cost here will be the potential return form investing this money elsewhere. It is normal to take a conservative cost for this type of funding which normally would be the best available short term bank deposit rate.

2. Sale of another asset

   Proceeds from the sale of an existing asset are often used to fund farm investment. Funds from the sale of a site are often used in this case. Again these funds also have an opportunity cost which is the potential return that could be gained from investing elsewhere.

3. Borrowed funds

   The interest rate charged by the lender is the obvious cost of this type of funding. The interest charged is allowable as a tax deductible expense against farm business profits. Whether the loan can be serviced by the business will be determined by the repayment amount which in turn is determined by:

   1. The amount borrowed
   2. The interest rate
   3. The term of the loan

It is important to remember that the full repayment (principle and interest) must be met from available cash. Using figures from the most recent set of farm accounts or from an eProfit Monitor analysis the ‘free’ cash available for loan repayments can be calculated. Availability of cash tends to vary considerably on most farms depending on the time of year, the type of farming system and the existing demands on cash. Repayment cashflow problems can occur when the amount borrowed or the interest rate are too high or where the loan term is too short. While both the interest rate and the loan term will generally be set by the lender, both are open to negotiation. The term of the loan can be tailored to match the level of borrowing and also can be matched to the life-span of the asset borrowed for. Generally farm buildings are borrowed for over a 10-15 year term. The longer the term the lower the repayment which will help business cashflow. However there is a cost involved in stretching the loan term in that over the term of the loan a greater amount of interest will be paid (Table 1). After extending the term it is important to commit to making extra repayments off the loan balance whenever excess cash becomes available as this will help to reduce the overall interest cost of the loan. Using this method of combining a lower repayment due to an extended loan term together with lump sum repayments when cash is available is a useful way to manage loan repayments.

In deciding the frequency of repayments you should first start with a clear idea of when during the year cash is available to meet repayments. Your Teagasc adviser can set you up with a cash flow recording system called the Cost Control Planner which will show you exactly how cash moves in and out of your business over the course of a year. Matching the loan repayments to the availability of cash will reduce the possibility of loan repayments being financed through your overdraft- which in effect is paying interest on the double. With the current trend of rising interest rates it is also a good idea to stress-test the loan by checking the effect that an increase of 2% in the loan interest rate will have on loan repayments.

Before taking on any new debt it is advisable to look at the existing debt commitments of the business. Listing out all the current business debt, using the headings in the following table, will give a good picture of the current debt servicing commitments. This will help you decide whether it is possible to meet the additional repayments from any new borrowing.

If it can be seen that cash flow may be under pressure with new loan commitments then one option may be to look at restructuring some of the existing debt and combining it with the new loan over a longer term. This course of action would only be a last resort and any loans targeted for restructuring should ideally be loans with long terms left to run or loans with high interest rates.

Conclusion

Before taking on extra debt it is important to have a good grasp of the available cash to meet loan repayments. It can also help to be aware of when the ‘peaks & troughs’ of cash flow occur during the year so that any repayments can be scheduled to match the ‘peaks’. In order to get the best deal on any loan it is important to have a clear idea of what you require, before approaching your lender. Be clear on how much you need, over what term and on what way your repayments will be structured. Having this information available will leave you in a better position to negotiate the best deal possible for the required loan.