The biggest question every farmer should ask when thinking about debt is “is it even possible to own a farm and be debt free?” Incurring debt is a normal part of running any business, especially in agriculture. There are a couple of reasons why any farm would incur debt.
- Short-term: Most often, a farming business will have a period in the year when it incurs a lot of expenses and a period when it receives a lot of income. It is during the in-between period when most farmers would take out a bridging loan. This all boils down to your budgeting skills. If your agribusiness has a well-structured budget, you will be able to anticipate when you would need the bridging loan. When harvest season rolls around and you are able to make an income from your crops, you should pay your loan back in full, cancelling out your short-term debt.
- Long-term: Farms might also incur debt when trying to acquire long-term assets, such as land or equipment. Farmers would then take out a larger loan and pay it back over a number of years.
So, why would you want debt in the first place?
The main benefit of taking out a loan is that you are enabled to acquire assets that could improve your business and farming practices. Instead of saving for years and years, you are able to have that land or that piece of equipment now, which can generate income. Not all debt is bad. The problem starts when your debt begins to overshadow your income.
When will I know that I have too much debt?
Life is tricky, especially when you’re trying to run a farm successfully. Because farming is so volatile, it can be difficult to predict the income you will make, and it could affect paying back your loans on time. Being able to recognise when your debt has built up is an essential aspect to running your business. There are some situations that could land you in a tight financial spot:
- Not budgeting correctly – without a proper budget, you might overestimate your income or underestimate your expenses, causing you to take out more loans than you can handle.
- Buying a “bargain” that doesn’t pay off in the long run – buying cheaper doesn’t always equal buying smarter. Farmers need assets that will last and making smart financial decisions (such as knowing when you can opt for the cheaper option, or when it’s better to spend more for quality) will go a long way towards not overspending.
- Sometimes, it’s just bad luck – droughts, theft and other variables outside your control can cause you to fall into debt. This is definitely the exception and working possible external factors into your budget can help stop you falling into this pit.
What can I do to plan for the future?
- Prepare a budget. Make sure that your budget is realistic and achievable.
- Follow your budget. Creating the guideline for your farm isn’t enough. You have to stick to it.
- Compare your assets and liabilities. To avoid falling into debt, you should always make sure that your current assets exceed your current liabilities by a ratio of 1:4 (no more than R1 debt for every R4 of income. You can always ask your accountant to help you calculate the ratio).
- Make sure that your current cash flow covers all your expenses (including interest on loans).
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