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General Comments – Newsletter April 2016

Review of clients’ financial performance over 2015, has revealed generally very strong performances for both livestock and crop producers. This coupled with increased land values resulting from strong local demand exceeding supply, has seen some large increases in Net Worth from 12 months ago, especially where costs have been constrained.

The strong positive cash flow from the last 12 months, has allowed most clients to reduce debt significantly, leading to the consolidation of their financial position, with a consequent reduction in the risk profile of the business.

These events have demonstrated the need to have a significant proportion of debt structured on a come-and-go basis, especially for large croppers who have large swings in cashflow. The best way to save on interest costs is to be able to retire debt, even if it is only on a temporary basis. Therefore, the structure of debt facilities is often more important than the absolute rate of interest being paid.

The current inverse yield curve for interest rates ie, where longer term eg 3 year money is cheaper than short term (3 month) money, provides a strong temptation to fix the interest rate on borrowings.

However before doing so, the structure of borrowings should be reviewed to make sure that it meets current requirements. Also a risk analysis of the business with respect to interest rates should be undertaken. If interest costs represent 20% of total costs, potential interest rate rises represent a significant risk to the business and a significant proportion of debt probably should be fixed interest. However, if interest costs are only 5% of total costs and Interest Cover (EBIT/interest expense) is greater than 3, there is unlikely to be a strong case or imperative to fix interest rates on a substantial proportion of borrowings.

Income tax planning for the 2015/2016 year will be important for those businesses which have enjoyed strong financial performance. However, when tax planning involving bringing forward expenses or delaying income, it is important to focus on the rate of tax saved ie. % of income/expenses, rather than the absolute sum of tax payable.

As businesses are growing and profits are consistently increasing, the rate of tax payable by clients is increasing due to higher averages. Under these circumstances, a higher rate of tax might ultimately be paid on deferred income.