2019 is bound to be an interesting year, what with a 20% deterioration of the Kwacha against the United States Dollar, from 9.98605 in January 2018 to 11.98035 on12th January 2019. This amounts to an inflation rate of 8.25% as of January 2019 against an improved real gross domestic growth rate of 3.8%in 2018, to an expected real growth rate of 4.5% in 2019.Additionally, changes to the tax structure with the replacement of value added tax by non-refundable government sales tax may increase costs further. It’s allup in the air as to where, what, how, why and when, but one thing’s for sure –austere times are coming.
Farming is expensive business. Gone are the days when you could grow crops or raise livestock without an elaborate investment in plant and machinery. Consequently, farmers purchase expensive long-term assets in order to produce crops or livestock at minimum cost. Attaining minimum cost requires scale and so it becomes a continuous cycle of reinvestment to achieve scale and profitability. This reinvestment in capital assets can sometimes be a significant drain on cash. Cash going out the business door reduces the value of a business. Furthermore, a significant number of commercial farmers carry huge debts from capitalization and yet they are structured as sole proprietors or partnerships, meaning they are personally liable for these debts. Discuss your structure with your accountant and you may find that limited, rather than personal liability, is more appropriate for your business. I discussed this in the October/November issue of The Zambian Farmer.
The absolute starting point is determining your strategy. Farmers sell commodities whose prices fluctuate. Commodities have no distinction or differentiation and farmer A’s wheat is no different from farmer B’s. And, we all know that commodities never earn a premium. Therefore, to earn large profits requires scale. Any farmer therefore has to be a low-cost producer to succeed and if he/she has any chance of reducing the time to profitability.
The commercial farmer usually has a contract with the buyer, detailing quantities to be delivered in the future at a predetermined price. The contract may be US dollar based or Kwacha or a mix of both. Since seasonal income is easily determinable, banks love the farmer and they will lend money to him or her in the form of short-term, mid-term and long-term financing, depending on the value of the collateral the farmer is willing to risk and the value of the crops and all other assets owned by the farmer. Bank loans tend to be over collateralized with bank risk being slim to nothing.
Protecting erosion of income streams is the farmer’s first consideration. Before signing away the farm and all, the farmer should shop around and see what rates of interest and terms are on offer. Important considerations are the rate of inflation and the “risk-free” rate of return on Zambian government treasury bills. Remember that you are competing for financing with the Zambian government and the banks want your offer to be compelling.
Figure 1. Returns per Bank of Zambia vs. Surplus interest charge by a typical commercial bank
The typical bank earns an extra 8% in interest by lending to the farmer rather than the government. This is why banks love the farmer. Most farming businesses hardly net profit margins of 8% on crops or livestock – real or nominal. So, whilst the banks may be a necessary and more willing lender than friends and family, the farmer should compute what he or she is paying to the bank in excess of what the government would pay. The illustrations below demonstrate that a 1%reduction in interest rates from 27% to 26% could save the farmer K5,800 in interest charges. Also remember that the banks will want to charge an arrangement fee of approximately 2.5% to 3% and there will usually be additional costs for insurance, legal and valuation fees that can easily add up an extra 6% in charges. Therefore the real cost of a loan can easily jump from 27% to 36%. The farmer must negotiate all these charges.
Figure 2. Seasonal [email protected] 27% interest charge
Figure 3. Seasonal [email protected] 26% interest charge