Farming is an industry that is constantly changing. Markets are extremely volatile, from crops and livestock to our inputs, and even the smallest external factors can have a significant effect. Interest rates can also change throughout the year. On the flip side, improved farming practices, further research and more advanced technologies mean that most farms are changing the way they operate year on year. As much as they may not like to admit it, farmers are incredibly adaptable.

While you adapt your business to these changes, one area that can sometimes be overlooked is finance. As your practices change and your financial needs adjust, it is important to review a few different areas to make sure your finances are keeping up with the business.

We have five financial health checks we suggest every business should complete each year. Some years, it will be a five minute check in with no changes required. Other times, it may require a little more analysis. Doing this each year should hopefully mean there are no major surprises and, in turn, keep the workload down.

1. Is your finance structure still right?

Loan structure can be an extremely overlooked way to reduce your overall interest costs. Each bank has different ways of offering loan products. Line fees, redraws, possible redraw fees, offsets and overdrafts are all product terms that are extremely important to understand, or to have someone in your corner who can explain them to you.

The way each business uses its loan facilities will vary greatly. Using the same product as your neighbour because they have a good deal does not mean it is the best option for your business.

Take, for example, two farming businesses that each have $2 million in term debt and an $800,000 overdraft. At the end of the season, Business A is able to fully pay down its overdraft, having used the entirety of that overdraft throughout the year for input costs. Business B, on the other hand, finds that it only pays down $300,000 of the overdraft following an average season. This most likely means that $500,000 of the overdraft is acting as permanent debt, while the business’s fluctuating working capital requirement is closer to $300,000. A more suitable structure may involve shifting the $500,000 of permanent debt into a longer term facility, which will usually come with a lower interest rate.

If Business A has surplus cash at the end of the season, a redraw or offset facility on its term debt may be a smart way to reduce interest costs on the larger loan. Many people simply pay down whichever loan they are already making repayments on, but often they will save more interest by reducing the facility with the highest interest rate first. If redraw or offset facilities are available, they can also help reduce interest costs while still providing access to those funds if they are needed later.

Other structural considerations include whether you are only paying interest on a loan that you should be making principal reductions on. Are you also paying interest at a time that suits your income? If you are a grain farmer paying interest monthly, moving to an annual repayment timed around when you usually receive your grain proceeds may reduce financial pressure throughout the year.

Understanding how your business operates is extremely important when determining the best facilities for your loans. This is why we complete an annual check in with our clients. When we begin working with new clients, we very rarely keep their existing finance structure exactly the same.

2. Are you still getting a competitive deal?

“Am I on a good interest rate?” is understandably one of our most frequently asked questions.

Interest rates are not black and white, with a variety of factors contributing to your customer margin. Profitability, equity, loan amounts, historical performance, projected performance and management practices all contribute to your customer rate. Asking your mate over the fence about their rate will rarely provide much insight into whether your own rate is competitive. It can be almost impossible to determine whether you are receiving the rate you deserve without comparing your position with another bank.

We are not suggesting that you move your business to a new bank each year. However, negotiating with your current bank and asking it to explain what improvements could be made to reduce your interest rate is a good starting point. If it has been a while since you reviewed external options and you feel your business is not seeing any changes from your current bank, it may be worthwhile exploring other options.

One benefit of working with us is that we have a solid understanding of the market. Once a month, we review our clients’ rates. By having a thorough understanding of each business’s position and the factors contributing to its rates, we can determine whether a rate is sitting outside what we would expect. With no additional work required from the client, we will usually nudge the banker to sharpen their pencil.

Recently, we achieved a reduction of 0.30% for a client during their annual review. Despite several poorer seasons and the business’s profit not being particularly high, the client had made significant changes to their management practices and achieved reasonable results despite the conditions. Clearly explaining this to the banker helped secure a rate reduction at the client’s next review, without requiring any additional effort from them.

3. Do you know your borrowing capacity?

Borrowing capacity is a standard figure in the world of home loans because it is relatively black and white. When it comes to farming, this figure can become a little greyer. However, it is still one of the most important numbers to understand for your business, even if you are not currently looking to purchase land.

Knowing your current lending compared with the amount your business can comfortably support allows you to prepare for both opportunities and challenges.

Recent tougher seasons have highlighted the importance of this more than ever. There is a maximum amount a bank will be comfortable lending to your business. This amount can sometimes increase during poor seasonal conditions, but there will still be a limit. If you find that you are nearing the top of your borrowing capacity during a tougher season, reducing debt should become a priority when better seasons return. This helps ensure your bank remains comfortable supporting you when the business is faced with adversity.

When seasons hopefully return to average, if you are still operating near the borrowing capacity your bank was comfortable supporting during a tough season, it may be unable to provide further assistance if another poor season occurs. Understanding where you sit allows you to prepare before your debt becomes too high.

If your business is looking to expand, understanding your borrowing capacity can be key. If you are looking to purchase land you currently lease, your capacity may not change significantly because the purchase will not generate much additional income. Purchasing new land may increase your capacity through the additional income it generates, and understanding your current position can help you determine an appropriate purchase price.

If you have plans to purchase the neighbour’s block and know you may need to pay a premium for its convenience, reducing debt during good seasons can put you in a stronger position to act when the opportunity arises.

If you are looking to purchase machinery, using equipment finance may help preserve your broader borrowing capacity. Paying for machinery directly from cash flow may affect that capacity. Although it may provide an interest saving, if you do not understand where you sit before making the purchase, it could limit your options later.

Your annual review with your bank manager can be a good opportunity to have a general discussion about where you are sitting. Unless you are seriously considering purchasing land, exact figures are not always necessary. Simply having a general understanding of your position may be enough to help guide your decisions.

4. Does your working capital still reflect today’s costs?

Following several tough seasons, temporary overdraft requirements have been increasing. However, we have also noticed that the overall cost of operating a farm has increased, meaning some farms’ working capital requirements may have risen permanently.

Increased costs for fertiliser, chemicals, wages, freight and leases, to name a few, may have materially increased the operating costs of your farm. Income has not necessarily kept pace with these increases. Even some of the most profitable businesses may find that they need a larger working capital facility during the year, simply because it costs more to grow the same crop or run the same livestock enterprise.

Reviewing your working capital requirements should involve preparing an annual budget. A cash flow budget can help determine whether an increased overdraft requirement is simply the result of one difficult season or whether your business needs a larger facility to operate comfortably.

It is also important to look at how your overdraft behaves throughout the year. Does it return to comfortable levels after harvest or livestock sales, or does it remain close to its limit year after year? If you consistently require temporary increases, it may indicate that your working capital facility is no longer large enough or that part of the debt should be restructured into a longer term loan.

5. Are your long term goals still the same?

Almost every financial decision comes back to one question: Where are you trying to take the business?

If your priority is expansion, borrowing capacity and being ready to act quickly when opportunities arise become important.

If your focus is preparing the business for the next generation, your lending strategy may need to shift towards reducing debt, restructuring facilities or improving long term sustainability.

If improving profitability is your goal, reviewing your interest rates, loan structure and finance costs may deliver the greatest benefit.

Finance is rarely the most exciting topic around the kitchen table, but almost every business goal has a financial component. Rather than jumping straight into loan discussions, we often begin by talking about what our clients are trying to achieve. Once those goals are clear, it becomes much easier to identify whether their finance is helping them get there.

Why do it?

Like servicing machinery before harvest, a financial review is a form of preventative maintenance. You are making sure your business is prepared for whatever comes next, whether that is another tough season, an opportunity to expand or simply another year of doing what you do best.

Sometimes the review confirms that you are on the right track. Other times, one small adjustment can save you money, improve your cash flow or put you in a stronger position for the future.