Transcript

3 Baron-Hay Court, South Perth Western Australia 6151Telephone: +61 (0)8 9368 3333 Fax: +61 (0)8 9474 2405Email: enquiries@dpird.wa.gov.au

Financial intelligence webinar 5: Managing financial risksIn the audio is:

Doug Watson, Consultant, Australian Facilitation Company

Transcript

Doug Watson:

Let's just recap where we've actually got to. We started the series with a session around understanding financial basics. Understanding, getting good quality information such that you can make good quality decisions and we ended up with three financial statements to be used for management purposes. That's quite important, because later on in this webinar, we'll be seeing how your accountant prepares those three financial statements for the tax office to keep the Australian Securities Investment Commission happy. Not so much for management purposes. There are some significant differences there.

We prepared those three financial statements. Then in the second series part of the webinar, we looked at longer term financial decisions by looking at the overall financial health of your farm, by looking at a number of key ratios. Those ratios covered short, medium and long-term decisions. The long-term decisions were about what do we do with the profit and really depended upon the life cycle of your farm as to leaving it in the farm, paying off debt, taking some out and preparing for retirement. There was a whole range of different options that you could look to do to sustainably grow your wealth as the owners of the farm.

In the third webinar, we looked at medium-term financial decision, those one to three years sort of decisions. We looked at profit and loss and cost of production and we focused on how we can improve our revenue and maybe reduce our overheads. We introduced this concept of the 6,1,5 model. Can we increase our revenue by 6%? Can we reduce our variable cost by 1% of revenue? Can we reduce our overheads by 5%?

We continue that theme on into the fourth webinar where we looked at that reducing your variable costs by 1% of revenue. A lot of seasonal type decisions and a focus on cashflows. Making sure that we've got enough cash to pay our bills when they fall due.

This last in the series of five webinars is about risk management, more specifically financial risk management that covers all of the different aspects that we've been talking about so far. In fact, many of the decisions we've been talking about in the framework and the tools are about managing risk in the short, medium, and long-term from a financial perspective.

There are three or four other key aspects of financial risks that we haven't really covered and we're going to cover those today in this particular webinar to give you a complete perspective on things. We're going to look at relationships with your banker and with your accountant and using your financial software to its maximum capacity as well as looking at risk in general and getting you thinking about risk in your farm and financial risk in particular.

That's a bit of an overview of what we'll be looking at today and weve got three key learning outcomes that we're trying to achieve. For risk management to be effective, we need to focus not just on the negatives, what could go wrong. We've also got to focus on the positives, that is what could go right.

When we define risk, risk is the chance of something happening that impacts upon your objectives. If your objectives in a financial sense are to grow the wealth of the owners in a sustainable manner, then anything that impacts on that either positively or negatively is defined as a risk.

Important to see risk as both positive and negative, because that then means in managing risk, we can either try and lessen the chance of the negative happening and improve the chance of the positive happening. A lot of the techniques we've been looking at so far about trying to improve yield, to improve the positive. Some are about trying to reduce the negative, use of herbicides, etc. Reduce something that could reduce yield. It's an interesting perspective to look at risk not just from a negative but also how can we promote the positive.

We're going to spend a little bit of time looking at business structures and your accountant and trying to understand taxation issues and how you're dealing with that. We're going to focus on working collaboratively with the partners in your business and those partners could be Department of Primary Industries and Regional Development presenting this webinar through to your farm consultants, through to your bank manager, as well as your accountant. A range of different focuses there.

Let's get into the topic today, which is around managing risk. We're going to use a framework that has been designed by ... It's an international standard actually around risk management. It basically has four key parts to it. Establish the context of the risk. The circumstances within which you're operating. Risk in your farm may be different to a farm 100 kilometres north due to your different circumstances.

This has been a key theme as we've gone through all five webinars is to look at maybe benchmarking against yourself rather than benchmarking against a model ideal farm, or at least be aware of the shortcomings if you were doing that.

When establishing the context in risk, what you're really saying is, "Here's my situation. It may be different to others. This is what it means in terms of risk management for me. If you don't identify a risk, you can't manage it, so the second step is to identify the risk. Then we assess the risk, the level that, that risk is. Is it at an acceptable level or is it too high, and we need to do something about it.

Lastly, we look to treat the risk to deal with it in a manner that reduces the chance of it happening or the impact if it does. We're going to look at the four key parts of managing risk when we look at that treatment option. That's the basic layout, and then we'll talk about some specific financial risks once we've been through this model.

Let's look at establishing the context, the very first part of that framework and model. In essence here, a good way to do this is to build a bit of a SWOT analysis for your farm. SWOT is an acronym, stands for strengths, weaknesses, opportunities and threats. I'm going to add an extra column here and call it constraints and I'll explain why in a minute.

There's a whole bunch of things that happen in your farm that you have some control over. These are internal to your business. We call the positive things strengths and the negative things weaknesses. You might have good quality people who are very competent in what they're doing. There's the strength. Maybe you got some new people in the farm that aren't as experienced, maybe that's a weakness.

We can look a bunch of headings there to say, "Well, what are the strengths and weaknesses internally in the farm to describe my context?" We're establishing the context by looking at a SWOT type analysis. We can do that similar process for the operations of the farm. Maybe the age of your machinery is different to the farm next door, so that creates a different range of risks. Maybe different stakeholders. Maybe your enterprise mix will make your farm and the context different to others.

There could be historical issues that you need to consider. Financial considerations. How much you can borrow, how much you can't borrow. What conditions the bank may have put on lending, etc. We look internally to things that we can do something about as the first part of establishing the context.

Next, we look at external to the farm. The things that we can't do a lot about in terms of changing them. We've got to respond to them. For strengths and weaknesses, we can be rather proactive and trying to address those internally. For external issues, opportunities and threats, we need to identify them and try and deal with them as best we can, because we can't stop them. Market conditions, prices, etc. Economic conditions, growth in the economy or growth in worldwide economies and markets that you may be selling to.

I guess just recently with issues raised on 60 Minutes about sheep exports, these are external things that we need to consider as we're establishing opportunities and threats to help identify some of the risks involved in my particular business. Technology and even the environmental sort of issues. Social considerations. Changes in tastes. Use of technology like the Internet, etc.

Your homework activity actually has some thought starters around all of these different areas to help you build a SWOTC analysis for your farm. This is the starting point in terms of establishing the context to help build a risk management plan for your farm. You can see in terms of constraints, these things are things that we just have to accept and deal with. We cant influence. We maybe cant actually try and address them. We just have contingency plans if they happen.

The geography, weather, maybe some laws that are in place. It could be a whole range of different things. Your homework actually gives you some dot points and examples to help you identify strengths, weaknesses, opportunities and threats.

If you spend a fair bit of time on this sort of stuff up front, then identifying the risk becomes a bit easier, because as you're identifying the opportunities, strengths and weaknesses, it's helping you identify the risks involved in your farm. If we can invest time upfront, then it makes the next stage of identifying risks a fair bit easier.

Now, some risks on the farm, we're going to look at them from a range of different perspectives and identify the main ones that many farmers show or identify when they do these sort of analysis. They can be risks around your yield. They can be risks around marketing pricing. They can be operational risks that you need to consider. We're going to zero in and focus a bit on the financial side of things. Obviously, they can be statutory and people sort of issues.

These are common ones, but I just encourage you in terms of your farm, it may be different. You might need to think more broadly than the ones we've identified. Look to what's happened in the past and what might happen in the future. Maybe look at your enterprise type and the risks associated with wool, versus lamb, versus crops, maybe different.

You need to think more broadly and not just say, "Oh, well, here's six categories. There's where my risks fit." We're showing them there as common risks that most farms need to deal with. We're going to zero in on the financial. That's not to say these others aren't important because obviously they impact upon the financial risks of your particular business. Have a think about what are the main risks in your business. In doing so, one way to actually cope with that and trying to identify the main risks is how you assess the risks.

This matrix is a way within this international standard that risks are assessed. How you identify the important risks that you need to do something about versus the things that are maybe you just need to accept and actually work with. Let me just explain the table.

On the vertical axis, we have the likelihood of something happening. You can see we've got unlikely, likely and very likely. On the horizontal axis, we have the impact. What would be the impact if it does happen? Minor, moderate or major? If we were looking at this risk table from a financial perspective, we want to say, "A minor risk in my farm is something that could cost up to $10,000."

Now, that depends on your farm and it depends on your financial situation as to how much that dollar amount is. We might say that moderate is somewhere between $10,000 and $50,000. Major might be something more than $50,000. We define those bottom impacts. If we were looking outside of finance and considering some other aspect of risk, we might have different criteria there. We're looking at financial, so we're going to put dollars and cents.

For example, safety might be a major risk. Might be something that could cause death or permanent injury. Whereas minor might just cause a treatment in the Outpatients, but we're looking at financial. You can define these differently depending upon the risk you're looking at.

Unlikely might be, well, it might happen once every 10 years or likely might happen once every 3 to 10 years. Very likely might be, well, it's probably going to happen once in the next three years. We use those sort of definitions and those definitions can vary depending upon your understanding of things and your willingness to accept a risk I guess.

Then we look at all the different risks we've identified and we say, "Well, how likely are they and how bad would they be if they happen?" We then can position these risks and grade them. Extreme, high, maybe medium or low. That then means that we can prioritize the different risks in terms of where are we going to invest our time, effort and energy to address them.

Obviously, we would start with the extreme and then move to the high, and maybe we'd address the medium sort of risks and maybe we'd might say, "Oh, well, we've just got to accept the low risks rather than beating ourselves up and investing a lot of time and effort and energy, let's invest it in the major ones. That might be to the right-hand, upper side of this particular grid.

There's a way that we can actually assess risk. Once we've assessed the risk, we then treat the risk. There's four broad ways that we can treat the risk according to this international standard. We can avoid it. We just don't do it. Unfortunately, the biggest risk of all is to take no risk. If we're always avoiding risk and saying, "We'll never take it." Then we'll never do anything.

We need to accept the certain level of risk. We can't avoid everything, but sometimes, there's a really good alternative. For example, when we are talking about medium term financial decisions, we said, "Maybe buy a second hand plant and equipment. Maybe don't borrow and postpone your purchase for a year or two until you have some more cash."

What you're doing there is avoiding the financial risk of borrowing too much money, by doing something else and looking at the alternatives. Avoiding is one option. We can transfer the risk to someone else. A typical example of this might be outsourcing of aspects of your farm to someone else. It might be insurance. It might be that you look at some forward rates in terms of commodity prices or fixed rates in terms of your loan.

Importantly here, what you need to think about is that whilst you may transfer the risk to someone else, it can be contagious. If you take out an insurance policy and then have a big claim, then your premium is probably going to go up next year. If you outsource your harvesting to a contractor, then you are dependent upon the quality of the contractor's work. If it's not good, it can come back and impact upon you.

Don't think that you've dealt with the risk when you transfer it to someone. The third way that you can deal with a risk, and this is the most common way, is that you mitigate it. You reduce the likelihood and/or reduce the impact of it happening. Pest control and budgeting might reduce the likelihood of a financial risk, whereas diversification and paying down debt may reduce the impact.

If I reduce my debt, then if interest rates go up, it's not going to have as big an impact upon my business as if I hadn't paid off any of the loan. Mitigation is about reducing the likelihood of the impact, and the fourth technique is around accepting the risk. That is, there's nothing I can do about it. I've got to live with it, so let's build some contingency plans. A lot of those constraints we talked about in the SWOTC analysis would probably fall into this category around acceptance. Four broad ways that you can manage the risk.

I've got some specific examples here of how people can use those four techniques to treat farm risk. For prices for example ... Thanks Simone. We have got underway, so obviously there will be a replay available of the first bit that you may have missed.

In terms of treating farm risk, we got a range of different options here and some references to help you as well. In terms of prices, we've been talking about this as we've gone through in terms of budgeting and forecasting and estimating is to be conservative. An important point here is to think about the median prices rather than average.

Averages are often skewed by some outliers, some higher prices that people may have got. As it says there, average price is usually higher than the most frequent price, so let's not confuse the two. It might help if we use a range in our estimating. There are some references there that might actually help you in terms of establishing the probabilities and setting those ranges for prices.

When it comes to yield, maybe it's about using your farm data to actually see where those ranges may actually sit. What is the probability of these yields happening. Combine that with a forecast and other tools that you can use and you can also compare the regional averages. We've given you a website there to actually consider.

When it comes to financial risk, how do people manage that, sometimes they look at fixed rates in terms of managing the risk of interest rates going up. If you're trying to estimate your variable rate for the coming year, then the one year fixed rate is often a good indication of what the market believes the rate will be on average over the next 12 months. That's basically the definition of a fixed rate. It's what the market is suggesting the average will be for the next 12 months.

If you're projecting out for three years, look at the three-year interest rate. There's an average. You might need to add a margin on if the bank adds a margin to your lending. For some people, to deal with interest rates and the risk of them going up, they may look to lock in a rate.

Then the last one just in general, we talk about when you are estimating and projecting in a financial sense, be aware of major events. A given example of there of very high yields in general in 2013 with wheat harvest in WA. That would be skewing some of the averages. You need to consider that.

The last one I think is very important one in terms of some research around a positive correlation between grain prices. Oats, barley, canola, wheat generally move up and down together. It's not always, but historically, there is a positive correlation happening there.

Interestingly, there is a negative correlation between grain and livestock if we look at wool and meat. That is if grain is up, wool and meat may be a little bit down, but if grain prices are down, then potentially on average, there's a chance that wool and meat will be up. This is one of the essences behind the value of diversifying your farm to include livestock within the farm as a natural edge in mixed farming enterprises. If we look at the medium to long-term, this negative correlation helps manage the risk in terms of the overall income for your farm rather than just looking by enterprise type.

Weve spent a little bit of time there actually going through the different aspects of risk in farming. I want to stop there and see if anyone has any particular questions that you'd like to ask before we move on to the next section. We will be having a break at about the 45-minute mark, so we're probably 10 minutes or so away from that. If you could think of any questions about risk and that approach of: establish the context, identify the risk, assess the risk and then treat the risk.

Just seeing if anyone is typing any questions. Can't see any typing. As I said, your homework activity actually takes you through those four steps and asks you to identify the top five financial risks on your farm. This may reinforce stuff we've talked about in webinars one to four if your risks are about debt levels or if your risks are about to not diversified enough. If your risks are about machinery, what should I be doing in terms of updating that?

We talked about lots of these issues in webinars one to four, so this particular topic of risk management is not a stand-alone. It is a continuation of some of the other webinar topics that we've actually talked about and bringing it into a bit of a summary. No one typed anything there, so I'm imagining and hoping that, that's worked pretty well in terms of talking about risk.

I want to move on and talk about three specific risks that we haven't talked about so far in webinars one to four and the risks are of a financial nature. Let's address those. The first one I want to address is working with your bank. I might be a bit biased here having worked as a banker in the past, but banks are there to help. Trust and they're there to help. They don't want you to see you struggling. They want to see you doing well because that means you're going to pay the interest and pay the loan back and then they can lend that money to someone else and that's how banks work.

It pays to work collaboratively in partnership with your bank. We're just going to look at financial risk from a bankers perspective. The sort of things that they'll be looking at, and I want you to think about your relationship with your banker and are you addressing these sort of issues and trying to see it from their perspective, such that you can build a strong working relationship.

If you have a strong working relationship, they're more likely to support you if things get tough or if you have new requests for lending. It's important to have the support of your bank if at all possible. Let's look at how a bank looks at financial risk and we're going to look at the six Cs that a bank may look at. The first one is around character. Honesty, integrity, trust. Banks don't like nasty surprises. Tell them the truth. Don't sugarcoat it. Give them early warning.

This character also includes the financial acumen and the farming abilities of the people in the farm. The more financial information that you start to use and discuss with your bank, the more comfortable they get that you know what you're talking about. You have a degree of ability in this area, and that give some confidence to actually back you. Honesty, integrity, trust, financial acumen, farming acumen, decision making, that sort of thing. Be of good character.

Capital. Capital has to do with the percentage of equity you have in your farm. You build it up over time, and it's one of the reasons we suggested that as you make profit, you try and build the equity in your farm. It creates a safety margin, because I guess banks are using the farm as security and we'll look at that in a minute when we talk about collateral. It gives you the scope to maybe borrow a bit more if times are tough if you've built up capital in your farm. If you've built up equity in your farm.

The third thing banks look at, they look at things around conditions. They look at the things you identified in your SWOTC analysis. Are you aware of them? Are you addressing these risks that we've talked about so far? They think about your planning and your budgeting. From this, they may actually put loan conditions on your borrowings in terms of certain ratios or certain milestones to actually achieve.

The more you can get good at presenting quality financial information, maybe using some of those ranges and good assumptions and justifying the decisions and the amounts that you've put in to your financial projections, then the more comfortable the bank will actually get.

Fourth one we're looking at is collateral. The bank wants security. This is their second way out. Their first way out is through cashflow. The farm makes enough cash to pay the interest. The second way out is that they sell something to get their money back. In a lease, it may be that piece of plant. They look for collateral. The more collateral they have, basically the happier they are, because it makes their position a lot safer.

Especially if you're looking at off-farm investments, then they'll be looking at that collateral to back up. It's about you maintaining the quality and knowing the market value of the collateral that you've offered to the bank as their security. We talked about that in terms of building your own balance sheet and putting market values on the assets that the business owns. We look at cashflow, the quality of your cashflow, the safety margins in your cashflow, the quality, the assumptions that you've actually made. As we spoke about in webinar four, cash is king. Profit, revenue is vanity. Profit is sanity. Cash is reality.

Cashflow, banks will often ask for that 12 month cashflow. They want to see that you're going back into credit at least once a year in your overdraft and that you're meeting all of your financial commitments and can pay your bills when they fall due.

The last one sort of touches a bit on all of them in terms of good communication. As I said, right at the start, banks don't like nasty surprises. The more you can communicate with them and the earlier that you can give them a heads up of positive or maybe even negative issues happening, then the better they are going to be positioned to actually deal with it and try and support you through any issues that you're facing.

Let's look at one more slide around managing the relationship with your banker and then we'll have a bit of a break and let you stretch your legs, etc. One of the financial risks in terms of banks is obviously the cost of finances. I'm going to come up with six different strategies or tactics to try and get the best value you can from your banker.

Every year, your bank reviews you. There's an annual review. I think there's a lot to be said for building up a good relationship with your bank over time. That doesn't mean to say that maybe you need to review your bank from time to time. Just as they're reviewing you and seeing whether you're a good customer and whether they will continue to support you, etc, should you be reviewing your bank and seeing what else is actually out there. Are there better deals?

My advice would be to try and stay with your bank and build that relationship over time, but to check the marketplace and see if there are other options out there and maybe use that as a negotiation discussion point with your bank to improve and reduce the financial cost that you're actually paying.

Second tip. Banks usually add a margin on top of a base rate to work out your lending rate. They say, "Here's the cost of funds." Let's say 5%. And for your farm, we assess the risk at one and a half percent. So you're going to pay six and a half percent on some sort of term borrowings. It might be bigger on an overdraft. The bank takes the cost of funds and they add a margin on to reflect the risk they see in lending to you.

Then the question becomes to me ... Well, the question you should ask the bank is, "What can I do to reduce that risk?" Many of the things we've already talked about will probably form part of the response they come back with. In an ideal world, try and get your bank to agree to, "If you can do this, this and this, then that reduces the risk to this level, your interest rate will go to there.

I think you'll get a bit of a pushback from your bank, because they don't like to commit to things like that, but I think it would be a good discussion to actually have. If the margin is to do with risk, then what can you do to reduce risk from the bank's perspective? If you did that, how much would that mean in terms of reduction in interest rate?

Then try and hold the bank to that commitment. You may not be able to get a firm commitment in terms of reduction in rate, but I think it is a good discussion to have and it makes sense. It uses the bank's sense, because if the bank is adding a margin to cover financial risk, then it makes sense to say, "Well, if I can reduce that risk, what are you going to do about my margin?"

Try and get a commitment. If not in writing, then in principle would be a good negotiation point for the next time when you meet them and you address those risks. Make sure that your finances are set up correctly. Don't have a hardcore debt in your overdraft. That is, it never gets back to zero.

Overdrafts generally get charged at a higher interest rate. You want to make sure that, that hardcore debt is maybe in some sort of term borrowings that is at a lower interest rate. Make sure that your overdraft goes back into credit on a regular basis. Some people might also use an offset account if your bank has this facility where you have money on deposit can offset against money you have borrowed and then you only get charged interests on the net difference between the two. Given the seasonal nature of farming, that might be a good structure in terms of many farms.

Look at those six Cs that we spoke about and consider the risks and you might, for example, offer more security for a return as a reduction in interest rate. Could be an option to consider. We did talk about fixed rates before and this is about managing the risk of interest rates going up. I do have a personal view on interest rates. That is I've never fixed one. Primarily because I could usually cope with the change in interest rates.

People tend to fix interest rates for the wrong reason. They fix rates because, "Hey, this five-year rate looks really good and I think it will be cheaper than the variable rate over five years." What I've already said is that the five-year rate is a balance between what investors are willing to invest at and borrowers are willing to borrow at. It is what the market expects the interest rates to be over the next five years.

For you to come out on top on that by locking into a rate and thinking you get a better deal than the variable rate, you've got to know better than the market. You got to know more about interest rates than other people. For me, if you're trying to lock in a fixed rate because you think it will be cheaper in the long run, then it's like going to the casino. The odds are stacked against you, because the people, the other side that are prepared to put their money aside for that fixed rate of that interest rate know more about interest rates than you do. They're large super funds, large businesses, they're banks themselves.

There are reasons to fix the rate. A peace of mind, a consistency of cashflow, can't afford rates to go up, but thinking that you can outguess the market is probably not one of them. Make a decision to fix the rate on the right reasons.

We've talked about this in webinar two. Make sure that you are addressing your level of debt and paying off debt over time such that you're replacing it with equity in terms of the funding of the farm. Assets equals liabilities plus equity. Boost the equity, reduce the liabilities. That will lower the risk involved in your farm.

Let's get back underway. As you see from the chat box, so just asking for any other questions people may have over what we talked about so far, risk management and, indeed, trying to get the best value out of your bank. Seeing things from their perspective and trying to make their life easier will help make your life easier as well. I think you've also got to be a bit assertive there as well and ask for the best deal and try and negotiate things etc.

Okay. No one else typing anything in there. The last two sort of financial risk type issues we're talking about are going to be with in terms of working with your accountant and the reporting that they prepare, especially around taxation. Then we're going to move briefly onto your software that you actually use your financial software and identify some of the potential risks there, and then we can wrap things up from there.

Our first slide in terms of working with the accountant is a bit of a prompt and reminder about some of the key differences between accounting figures and management figures. The key focus here and the key thing to understand is your accountant is preparing figures to keep regulators happy. The tax office, ASIC, whoever. Whereas your management figures that we've been talking about especially in webinar one into terms of preparing your profit and loss, your balance sheet and your cashflow are more about management decisions.

Given that they're for two different purposes, then they're going to be different in terms of the numbers that are presented. For a start, I guess your accountant is preparing on a tax year, whereas you might prepare things on a seasonal basis because it makes more sense in terms of your management decisions. For your accountant, a lot of the values within your financial statements will be historical. They won't be market value. Whereas we've said for making good management decisions, maybe we need to include market values especially around the assets that we actually have and prepare it on a seasonal basis.

Some figures prepared might be done on a cash basis with no adjustments for things like debtors and creditors and tradable assets that we talked about in webinar one. Some might be prepared on an accrual basis that do include those sort of adjustments. A good question to ask your accountant is on what basis are these figures being prepared.

The tax office is quite happy I think. It might actually be $2 million now, but definitely at $1 million turnover or less that you can prepare things on a cash basis, which is quicker and simpler and easier, but as we've seen, doesn't give you the quality of information for good decision-making. We've prepared our management figures on a mix of cash and accrual basis.

Sometimes, we look at when the money arrives into our bank account and goes out. Other times, we've been looking at these adjusting type entries. Lastly, there, for example, depending on your business structure, whether the drawings you take from a farm actually appear in your financial statements and how they appear. Whereas in our management figures, we've said, "Let's put an amount in there to reflect the amount of time and effort and energy the familys putting into running the farm."

We came up with this notional management fee to recognize that time and effort and energy. It may not be a true dollars and cents amount, but is reflective of the time, effort and energy that's actually been put in. Some key differences there between your accountant's figures and management figures.

There's probably two adjustments that your accountant may make in your financial statements that we haven't talked about so far. In the interest of understanding some of those information your accountant presents, let's look at those two bits of information. These are contained in your notes, your handout. It gives you more details around this and your accountant will often put in things like prepayments and depreciation.

The reason I've lumped these two together is they are of a similar nature. That is we pay for things up front and then if we want to match revenue with expenditures, we spread them out over time. For example, if we pay our annual insurance in September, then by the time June comes around for your tax return, you've used nine months of that insurance, not 12 months. That's what a prepayment is. It's a way to get the nine months of insurance into that tax year's profit and loss, not the 12 months.

It's not fair to put 12 months worth of insurance against nine months worth of revenue. Prepayments, you'll often see appearing in your assets, your prepaid insurance expense or you can prepay interests. For example, you can prepay quite a few different things. Your accountant may find a way to spread that out to match it with the revenue it's helping you generate.

The same thing applies to depreciation. We buy an item, a plant or machinery or we put improvements into our yards. We buy some technology to help ... When we talk about technology in terms of working with our flock, we buy some of that technology. What depreciation is, is it's the allocation of the purchase price of an asset over its useful life.

If we bought something worth $50,000 and we thought it was going to last 10 years, then the appropriate thing to do from an accounting perspective would be to allocate $5000 a year for 10 years as an expense. The cashflow is the 50,000 we paid for the item of plant and that will show up in my cash and in my balance sheet as an asset. Then every year, what I do is I take $5000 off the value of that asset and I put it in as an expense.

My asset goes down by five and then expense, called depreciation, goes up by five. At the end of 10 years, that's assets in your books at zero. Now remember, that's a book value, it's not a market value. Depreciation is not an attempt to put a market value on your plant and equipment. It's an attempt to take the cost of it and allocate it over its life. The life that it has to help you generate revenue, and in doing so, we're matching revenue with expenditure.

This is explained more fully in your notes, and there's a bit of an example there. One thing I will touch on though is that there's two methods that the tax department allow you to depreciate with. They use different formulas to calculate the amount. One is basically a straight line just as I explained, $5000 a year for 10 years. The other one is what they called diminishing value. It has more depreciation upfront and less towards the end.

It's a different formula, but it's the same principle. You're allocating the purchase price over the useful life of the asset. Generally, the allocation is done on the basis of the tax office rates, how they'll allow you to depreciate. They publish a whole series of rates. Which method of depreciation people choose, straight line or diminishing value. Be guided by your accountant, because it's going to have tax implications, etc.

Key thing for me is when you look at your financial figures from your accountant and you look at the value of your plan and equipment, that is a book value. It's not a market value. We said for management decisions, consider the market value.

The second series of things an accountant may do is they raise provisions and accruals. This has to do with based on doing something today, we've got to pay an expense in the future. We want to record it today because it's based on what we did today. The easiest one to think of this is if you have any permanent employees, you're going to owe them annual leave. As a result of working this month, you might owe them two days annual leave for this month.

You create a provision for annual leave, which is a liability and then you create an expense called annual leave expense even though they haven't taken the leave. You now owe it to them. If they left tomorrow, you have to pay them. If you want to match revenue with expenditure, you need to create a liability as you owe this money to people.

You might see provisions in your financial statements for things like super, annual leave, GST, because you owe this money to people as a result of what you've already done, and that's essentially what provisions and accruals are actually doing. Once again, this is explained more fully in your notes, but just in an effort to help you understand some of the figures that your accountant may put together.

Now, generally, we said your accountant is aimed at producing figures to keep the tax man happy, but also to keep you happy in terms of trying to legally minimize the amount of tax you pay. We're not talking about avoiding here, we're talking about minimizing, two different things. One, you might end up in jail, the other one you might end up a bit wealthier.

There's a range of mechanisms that accountants typically use and this will vary depending upon your specific circumstances. It's not meant to be a tax advice for you. This is more for you to understand some of the reasons why accountants are doing certain things.

The first thing is about the timing of income and expenditure. This depends on whether your accounts are prepared on a cash basis or on an accrual basis. You might be able to defer income, push it out into another tax year or bring expenditure forward into this tax year if you're having a very good year and you might end up paying too much tax.

What you are doing though is just creating a problem for next year, because if you defer the income from this year, it will show up next year. If you bring expenditure forward, then you don't have that expenditure for next year. You could end up paying more tax next year.

Generally, people use this approach because a bird in the hand is worth two in the bush, so I might as well minimize my tax this year and then worry about next year and next year, would be the general sort of way that people deal with this issue of timing. You may have your accountant talking to you about the potential to defer income or bring expenditure forward depending upon your specific circumstances.

You might bulk buy certain items, and if you're on a cash basis, that might bring expenditure forward. You might prepay a lease and the tax office allow you, I think, 13 lease payments in any year even if you only took the lease out in May. It's only been going one month. You might be able to make 13 payments in June or 12 payments in June, 13 in total and bring that expenditure forward into this year. The reason they're doing that is to minimize this year, but you are creating a problem for next year.

Farmers do have an option in terms of some specific tax effective investments around super, either self-managed super funds or various public ones. The SF is self-managed super funds or even farm management deposits to help even out your profit income, etc, over a number of years. Rather than getting tax on the high amount, at a higher rate. If you even it out over five years, then on average would pay less tax.

From time to time, there's a range of concessions that come along, and it makes sense to take full advantage of these. Sometimes, for example, after the global financial crisis, there was a bit of a special in terms of we'll allow you to depreciate plant and equipment up under certain conditions by twice its amount rather than just one times its amount. It was an effort to get people buying plant and equipment to stimulate the economy. Your accountant would be fully aware of all these different options that they're talking about here in terms of splitting and averaging in allowances and rebates and when is the best time to buy plant, etc.

It does pay to get a second opinion at times, especially when it's a major decision. Accountants may not be experts in financial planning, so you may need more support there for example compare what your accountants saying to your banker as well. Think about it from a few different angles and get a few different opinions is a good focus in terms of taxation tactics.

Lastly, as you're making decisions of a financial nature, maybe you need to keep in mind the after-tax position of that decision as much as the pre-tax decision. There might be a better way to do something to get a better after-tax scenario. A few different thoughts and generic in nature I know they are, but a specific tax advice would require your accountant to specifically look at your individual situation.

Some of the advice they give you will be depended upon the structure of your business. Let's have a look at some key structures and once again in your notes, some common advantages and disadvantages of these different structures are presented for you to consider, but hopefully you understand your structure and why it is that way. They all have pros and cons to them. You might start as a sole trader, which is quick and simple and easy to set up, but you're personally liable for debts and you pay tax at the personal tax rate.

You may then move to more of a partnership sort of setup where the partners are paying tax at their personal tax rate. You may have a partnership agreement. If you don't, then there's a generic one that applies to all partners under the Partnership Act. It doesn't cost much to set up, but it can be a bit cumbersome in terms of you need all the partners to agree, because they're all liable for the debt, joint and severally of the business.

The more people you get involved and the different opinions that you have involved, this can lead to challenges in terms of getting everyone on the same page. Now, banks are a bit wary about partnerships because if one partner decides that they dont want to continue and they notify the bank, then all accounts get frozen because now you have a separate legal entity, because one person has removed themselves from the partnership. Now, it's only the three remaining rather than the four that were there.

It can create problems if people aren't on the same page, but it does help you to spread some of your tax liabilities across the different players in the business. Some people set up a company and this involves shareholders and directors and you own shares. It costs a bit more to actually set up. I guess companies are taxed at ... I think it's 30 cents on the dollar. The government is trying to reduce that rate at the moment, which is less than the top marginal personal rates.

What companies do is they declare a dividend to the shareholders and that's how the owners of the business get their money back out of the business and then they have to pay tax at that personal rate. There is a concession that basically allows for the amount of corporate tax that was already been paid and that's called dividend imputation or franking of dividends so you don't have to pay the 25 cents or 30 cents on the dollar again. If your top marginal rate is 40 cents on the dollar, you've already paid 30 cents. You only have to pay the 10. In total, you're back to paying the personal income tax rates.

One of the big advantages of a company is that legal liability is now separate from the owners of the business. It now rests with the separate entity, the company itself. Lastly, many people might set up a trust and it might be a company as trustee for the investor. An individual as trustee for the trust. Importantly, trusts are not legal entities on their own. Trust is a relationship between two parties, the trust and whoever is the trustee.

What this allows for is a lot of flexibility in terms of the distribution of income and the individual beneficiaries paying tax at their marginal rate. It costs the most money to set up and to maintain, but can have a lot of flexibility in terms of a tax effective strategy around spreading income across if it's a family trust across family members especially if they're over 18. If they're under 18, they have to pay tax at the top marginal rate anyway, so there's not much point in distributing income to them. Or if they're earning income on their own, there's not much point distributing it to them because you might end up on the top marginal rate anyway.

A brief overview of some of the main types of business structures that can help in terms of a tax management, but they all have their pros and cons in terms of what might be the best option for you. Be guided by your accountant. Discuss them knowingly in full awareness of those pros and cons and use them to their best advantage in terms of managing your finances, especially around tax. Your notes include a bit more.

Three key questions then moving onto this third aspect of financial risk that I want you to think about, because if risk is about the chance of something negative and trying to avoid that or promoting the positive, then maybe our accounting software and better use of it is a way to promote the positive. If you're anything like me with programs I use, Word, Excel, etc, I'm probably only using 10% of its capabilities. How much are you actually using? Who uses it? How much support do you get? How happy are you with it?

A lot of the stuff we've talked about in webinars one to four, if you have good accounting software, it will take a lot of the legwork out of preparing the numbers and figures. It might take a bit to set up at the start, but it then makes it easier as in future years. You're also now building up a track record in history that you can go back and use to help manage your farm.

In 2017, a survey of NAB, about 739 of their customers identify that 69% of them use farm management software of some type. Have a think about yours. Given what we've talked about now, does it have the capacity to produce cashflows, profit and loss, balance sheets? Does it produce forecasts as well as actuals? Does it produce a comparison of your actuals to your forecasts? Does it help you in those sorts of ways? Or if you don't know, can you find out because you're not using those capabilities?

I've had a bit of feedback as we'd be going along and that's been one of the feedbacks is, "Oh, I now understand what this sort of tab, what this option is and why it's asking me those sort of questions." Have a think about your accounting software and is it appropriate and helping you. Are you getting the best value out of it? As you review it, maybe define the needs you have. Not just now, but also in the future.

Think about who is using it and the sort of enterprises you have. Does it have the capacity to deal with these different enterprises and the scale of our operation? Definitely, budgeting would be a key criteria in terms of looking at the capacity and capabilities of financial software.

Take the features of the software you're looking at and match it to your needs, how well does the software match the needs that you have. This should be good in terms of reviewing your existing software or maybe even thinking about upgrading or changing to different software. Look at ease of installation and the customization and how easy it is to enter data. Does it have all the functions that you're looking at, we've been looking at, things like gross margins and reconciling livestock.

Those tradable assets that we've been talking about. What does it actually report, by what levels, what enterprise? How can you edit and tailor and maybe even transmit those reports to some of your key collaborators in the farm? It might be good to get unbiased opinions from other users.

Thirdly, consider the practicality issues, the compatibility with the bank and your accountant. How does it work with your existing hardware for example. Do they have ongoing training and support? Maybe there's an opportunity to have a bit of a play before you actually buy.

A few key things to consider in terms of assessing the quality of your existing software and also thinking about the potential to actually upgrade. Before you do that, make sure you investigate the full capacity of your existing software, because maybe it can do the things you're looking for. It's just you need to know how. I guess if I knew software better, than maybe we wouldn't have the audio issues at the start. Still not sure what those issues were.

Let's get to one of our wrap-up slides in terms of thinking about what you might do differently as a result of what we've been talking about so far. We talked about those four steps in terms of identifying the risks in your farm, but in particular we've been focusing on financial risks. Establish the context, identify the risk, assess the risk, treat the risk.

We gave you a little framework for that to work within and that's the homework activity from this week. We give you a bit of an outline of a SWOT. We highlight some of the financial risks in there. Try in getting you thinking beyond the dot points that are there into what are the issues that you're actually facing. Then trying to get you to identify the top five risks and then say what are you going to do to treat those risks.

Now, in considering that, some of your risks might be to do with relationships with financial partners, your bank and accountant. Some of them might be to do with your bank and the cost of finances. Some of them might be to do with your tax strategy. Do consider those specific risks. Some of them might be to do with your financial software. Do consider those financial risks as you're looking at the five key risks that you're going to focus on and going through those steps of context, identify, assess and treat.

Understand your tax strategy. Ask some good questions of your accountant, why is it happening this way? Take ownership of it and jointly with the advice and support of your accountant, come up with a tax strategy that you're comfortable with and that matches your requirements. The last one that I've got here is working well with other partners, and in particular around your bank and trying to think the way a banker thinks and make their life easier because that will make your life easier, and it might make it cheaper as well if you can get a better deal.

A few key thoughts in terms of summarizing what was spoken about today. There are some really good references here in terms of some of things I was talking about, about averaging and probabilities and ranges, financial decision-making there. This is where the correlation data is presented in one of the appendices here as well around the correlation between grain versus livestock. Some good stuff there to actually click on and get a bit more information together with the notes that we've actually presented you with.

I've really enjoyed presenting this whole to you. I am very passionate about trying to help people do things better. When it comes to finances, I think we've given you a really good starting point to actually start to consider more the financial aspects of the decisions you make and bring that into your decision-making to improve the quality of your decision-making.

There are other options in terms of if you look at the DPIRD website around Plan, Prepare, Prosper, a five-day series of workshops as well as Planning for Profit, which is more of a one-day workshop. Thank you very much guys and thank you for the kind comments that are coming through in the chat box. I've really enjoyed working with you and I wish you all the best in terms of the future prosperity if we bring it back to that overall financial goal of sustainably growing the wealth of the owners: yourselves. Hopefully that happens in the future for you. Thanks very much and who knows we may work together, some days down the track. I've really appreciated it.

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