Have you ever heard the term “overcapitalisation”? If not, don’t worry, you’re not alone. But if you own a farm or agribusiness, or if you are looking to start one up, it’s vital that you get familiar with these terms.
Luckily Bertie Hamman, senior manager of agribusiness at Standard Bank, is here to teach us the difference. He also highlights the consequences of both as a part of our ongoing journey to help you become the best agribusiness owner you can be.
What is over- and undercapitalisation?
Under- and overcapitalisation are just fancy words for something you’re probably already familiar with. When your agribusiness becomes overcapitalised, it means that you have more assets than you need for your business. If you only need to plant 500 ha, but your tractors are actually equipped to plant 1000 ha, that means you are overcapitalised. Undercapitalisation is just the opposite. If you don’t have enough assets to do business, your business is undercapitalised. (Remember to watch the episode of Food For Mzansi TV, where Hamman breaks down how the relationship between cash flow, debt and assets affects your business.)
What are the consequences of being overcapitalised?
You might think that being overcapitalised is a good thing, but that’s the actual risk. Not only are you less profitable than you could be, but if a lot of your capital was on loan from the bank, you might have more debt obligations than you will be able to cover. (For a more detailed breakdown, watch the episode of Food For Mzansi TV where Hamman explains the situation using numbers.)
Most businesses that are overcapitalised tend to also have too much debt, and if you remember our previous episode on debt, you will know the problems that that can cause for any farm or agribusiness.
How can my agribusiness avoid becoming overcapitalised?
Of course, no business should aspire to be overcapitalised or undercapitalised, but rather to be smack dab in the middle of these two extremes. But how do you get your business to be optimally capitalised?
- Have a realistic objective: It all comes back to the budget. If your budget objective is realistic and attainable, you should be closer to achieving optimal capitalisation.
- Stick to your budget: Stop us if you’ve heard this one before. Having a strong budget with a realistic objective is one thing, but following it is something else. By sticking to your budget, you can make sure that you don’t overspend or acquire unnecessary assets.
- Spending too much on an asset: This can be a struggle for farmers, because very often the market value of a piece of land is far higher than the productive value of land. By spending premium prices for a piece of land or another asset can lead your business to become overcapitalised.
- Keep a realistic eye on agricultural and market trends: If you started your business in a boom period, your business could become overcapitalised when the sector starts to taper off, because you had assets that accounted for a booming agricultural market.
- Buying assets for the wrong reasons: If you acquire your assets at the end of the tax year to show a larger amount of assets, you could begin the next financial year with assets that you cannot properly employ, leading your business to become overcapitalised.