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Land and Environment : Agribusiness Assoc. of Australia
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Agribusiness Perspectives Papers 1997/98

Paper 6/5
ISSN 1442-6951


Putting The Family Back Into The Family Farm

Paper 5 - of a series of 6 papers

Geoff Tually
Senior Lecturer
Institute of Land and Food Resources,
The University of Melbourne
1997

[Paper: 1 | 2 | 3 | 4 | 5 | 6 ]

Growth is necessary if you are going to involve farm family members in the family farm business. To achieve this goal you need to plan for growth. Risk may effect your plans, so needs to be built into your plans.

This paper looks at the following three (3) aspects:

Risk and the farm family business;

Risk and using specialist farm service providers;

Risk and farm family plans: family, ownership and business plans.

1. Risk and the farm family business

Risk management is the term often used for developing strategies to protect some aspect of the farm family business or family goal.

TWO (2) basic aspects of risk management

i) Short term - annual activity, e.g., this years cropping and livestock program.

develop/use a spraying program to control pests and diseases to protect crops;

develop/use drenching program for sheep and cattle;

crop and livestock insurance;

futures and forward selling crops and livestock;

increasing hay reserves against risk of drought or drier periods;

key man insurance.

ii) Long term. Developing five (5) year plans to achieve growth. Needed for both business and family cash requirements.

develop family plan to achieve family goals, e.g., for education, both formal education (school and tertiary) and involving in farm family business. No current Will increases risk;

develop an ownership plan to involve children and provide for building up the business;

develop business to provide for growth for involving children.

Concentrating on the present, the annual picture, with little or no focus on the longer term is to INCREASE RISK of NOT achieving farm family goals. The ANNUAL focus program will reduce this years business risks. BUT you could LOSE the BUSINESS, if the longer term risk situations are not programmed, i.e., give EQUAL attention to both short and long term aspects for OVERALL risk management.

2. Risk and using specialist farm service providers

Specialist advice is provided by farm service providers. There is a risk that the specialist advice you seek/sought, may not be useful in terms of other areas of the farm business, i.e.,

reduce the problem in one area, but increase (perhaps greatly) a problem in another area (risk transfer) within the farm family business.

i) Taxation. Determining the annual tax liability. There are strategies for reducing the tax liability to be paid in any one (1) year.

deferring some of the tax liability, i.e., use IED’s;

income spreading, i.e., partnership, trusts;

buying ahead - buying this financial year for use in the next financial year, i.e., non depreciable items.

Spending cash to reduce tax liability, on depreciable items is NOT usually the most effective use of cash, e.g., purchase machine for $50,000 cash. Depreciation at 20% prime cost = $10,000. Profit reduced by $10,000.

Effect of this depreciation of $10,000 on tax liability at different marginal rates of tax.

Marginal rate of tax

Tax liability reduced by

Ratio

20c

$2,000

25/1

34c

$3,400

15/1

36c (company)

$3,600

14/1

43c

$4,300

12/1

47c

$4,700

11/1

at 20c marginal (individual) tax rate, spending $50,000, would reduce tax liability by $2000; OR spending $25 cash to save $1 of tax. (negative leverage).

Leasing or hire purchase would be more effective from a cash outflow position, than outright purchase in the one year, unless the cash is NOT needed by other areas of the farm family business or farm family.

ii) Technical production advice.

Agronomist was requested to carry out pasture trials for a dairy and cropping farm owner, as he wished to increase the herd size and reduce cropping. The farm was outside the more traditional dairy areas. I found, on inspection of the monthly herd milk production records, that production and length of lactation period were significantly below dairy production benchmarks;

instead of increasing the herd size, the herd should have been replaced with higher producers; herd size could be reduced by 20% as higher producers would have produced a greater quantity of milk (and need less pasture rather than more). Whilst this example is fairly extreme, I have heard of many similar examples, including feeding sheep in a drought until the bank foreclosed the farm account. Not looking at the whole farm business picture MAY INCREASE RISK.

3. Risk and farm family plans

A) Family plans and risk

i) Match cash generated by the farm family business to the cash needed by the family. If the eldest child is 10 years of age now, in five (5) years time will be fifteen (15) years of age and cash needs will considerably increase, see figure 1 (I).

ii) Talk with family and involve in all planning (as applicable to age) to reduce potential conflict as may occur, especially through poor or lack of communication.

iii) Have an up to date Will.

iv) Write your ideas down.

v) Plan for growth and family opportunities (and not how to provide children an inheritance).

B) Ownership plans and risk

i) Gifting. Increases risk of family members not talking together and losing farm business.

ii) Not recognising off farm income put into the farm business, i.e., by sons/daughters in law.

iii) Designing an appropriate ownership structure to reduce impact of divorce, etc.

iv) Have a written partnership agreement.

v) Have separate ownership structures for the farm business, off farm business and the land.

C) Business Plans and Risk

i) Annual planning (budgets based on last year) INCREASES RISK. Rather, you need to determine where you need/want to be in five (5) years time and work backwards to where you are today, REDUCES RISK. Then you develop the 5 year plan.

ii) Must plan to increase business profitability each year (depends on your cash needs position).

iii) Incorrectly using borrowed funds INCREASES RISK.

a 20 year loan is covered by 4 x 5 year plans;

always borrow for a longer period than you need when buying land and then pay off as soon as possible. Reduces risk of having to renegotiate a loan;

for farm business equipment, plan to repay loan before equipment reaches end of effective life, or loan (amount yet to repay), is less than trade in price. Equipment should pay for itself (compare ownership with leasing or renting);

first generation would have a different loan position to a second generation farm business operator (2nd generation has greater asset backing, generally).

iv) Rainfall fluctuations and borrowing risk.

Figure 1 (II) shows the annual rainfall fluctions for 107 years. Figure 1 (I) shows the general cash needs profiles for two generations.

In relation to these rainfall fluctuations (data for this graph obtained from meteorological bureau), would there be any best time to borrow from the bank (relate to trend line drawn freehand on the graph).

In relation to length of loan

for a twenty (20) year loan, how many years was the annual rainfall significantly below average rainfall, i.e., at least 10% or more below average between 1970 and 1990 (or any other 20 year period).

for a ten (10) year loan, same as above, i.e., 1980 - 1990.

now relate both length of loan periods to the cash needs profiles in Figure 1 (I).

Draw in your own trend line if you disagree with the one used for average rainfall.

A 25% below average rainfall line has been used in Figure 1 (II) and provides another budget line. If this line does not provide cover for loan interest, then relook at your borrowing strategy, (early part of loan), i.e., off farm income could be used to reduce borrowing amount or extend length of loan.

A twenty (20) year loan is upwards of 50% of your productive lifetime. Loans should be designed in terms of your goals. Why borrow (and possibly go without) to build up an asset, and then pass on to one (1) child or divide up between the children. Form a trust for the business and let all children help (buy in) in growing the business.

Plan to buy when the market is low or drier/drought conditions prevail, i.e., need to borrow less, OR plan to maximise farm business returns in good years to cover bad year.

Use the planning frame (Paper 2) and determine the risk situations with each section of the frame.

[Paper: 1 | 2 | 3 | 4 | 5 | 6 ]

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