Do I use FOREIGN CAPITAL or not?

August 2018

When setting a farming business, the first resource you need is capital – that is money. The money is needed to buy land, equipment, machinery, livestock and so forth.

How much capital you will need depends on the size of the farm, the type of farming you will be practising, the area and several other factors.

After you have set up your business you still will require additional capital for the daily running of your business. The implication is that you need a lot of money or capital being the more correct term to use. Those already in farming will agree, farming is one of the more costlier businesses to run.

The question then arises, where do I obtain the necessary capital? In broad terms there are two main sources of capital. One – you provide your own capital, or two, you borrow capital, from a third party (somebody else – either a person or business). The capital belongs to that somebody else and that is why it is referred to as foreign capital. This places you under an obligation to repay the capital you have borrowed.

Sources of own capital are either that you have money of your own available that you are willing to invest in your business for initial capital or for production capital. Normally once your business is up and running production capital is needed on an annual basis. The only way to provide your own capital for production purposes is when your business makes a profit. Remember the basic question – why do I run my own business? To make money (profit).

Unfortunately, a farming business, no matter the size, requires a lot of initial capital and then production capital and perhaps capital to expand your business. Thus, farmers, whether small or big, most of the time requires foreign capital. 

As already stated, borrowing foreign capital implies that the capital must be repaid with a further cost implication – interest. The third party from which you borrowed the capital needs to be compensated for the risk taken to borrow you the money. Thus, the repayment consists of capital plus interest. The cost of repayment (the interest) reduces your profit and in total the repayment has a negative effect on your cash-flow position.

Thus, the question should one use foreign capital or not is quite relevant. The basic answer is – do not use foreign capital, it is costly and puts you at risk. In a previous article we concluded that the best debt is cash. However, we all know from practical experience, at times you must borrow money to keep your business operational.

Bear in mind in principle whatever you have purchased with foreign capital belongs to the third party until the capital has been repaid. Should you not be able to repay, the item/s or your crop may be repossessed.

To decide to borrow money requires thorough management on your part, which begins with planning. The first aspects that need attention is whether you really need to borrow capital, and will you be able to repay the money and the cost involved. The only way to answer this is to compile a cash-flow statement. The cash-flow statement will also assist to decide should you borrow the money or are there alternative ways to overcome the need for the capital.

We know to plan and compile a cash-flow statement in the farming environment is very difficult because of factors beyond our control. Such as drought, the occurrence of bird flu and as of late the listerioses affecting pig producers. But any plan is better than no plan. 

Part of your planning and organising is to acquire all information from financial institutions willing to provide you with a loan. What are all their conditions about security, repayment period, interest rates and other? They will need security, preferably in the form of land but other forms of security will be considered. We often hear some small farmers complaining about this. Financial institutions will be willing to provide you with funds should you be able to prove to them that your business is profitable. Unfortunately, some small farmers do not manage their businesses properly and do not even have proper records.

When you have acquired a loan, part of the implementation is to repay on time. Should you not be able to repay, discuss it timeously with your service provider as part of your control function. A farmer who shows that he is responsible about paying his creditors, builds up a good credit record. This means he is a low-risk client and uses sensible credit purchases as a means of running his business.

Thus, using foreign capital is a burden with some risks involved, therefore it requires careful consideration. But as a farmer you might not have much of a choice than to use foreign capital – but do it responsibly.

Article submitted by Marius Greyling, Pula Imvula contributor. For more information, send an email to mariusg@mcgacc.co.za.

Publication: August 2018

Section: Pula/Imvula