Finance module

author: young

The financial components of the model includes:

  • interest

  • cashflow

  • a limit on capital borrowings

  • minimum return on expenditure

  • opportunity cost of assets

Each module tracks its relevant financial components. The finance module provides a common location to describe the finance section of the model and is also home to key finance functions that calculate the interest and working capital of each cashflow item.

To support the sporadic nature of farming income, finance is often drawn from the bank throughout the year to fund costly operations such as purchasing fertiliser and chemicals. In AFO the total capital required for the given farm structure is tallied and can be constrained to a user specified level. This allows the user to examine how the business structure would change if finance is limited. This can also be used to ensure the model doesn’t overdraw an unrealistic/undesired level of capital from the bank. Total farm capital required is calculated from the value of starting assets plus the sum of all the expenses minus any income, between the previous ‘main’ income (e.g. harvest or shearing) and the peak debt date. Peak debt is typically expected for an enterprise just before the main income is received for that enterprise, ensuring the main income for the enterprise is not included in the working capital constraint. The aim of the working capital constraint is to allow the user to constrain management practices which have high costs. If the main income was included in this constraint there would be no way to constrain high cost high reward management practices. The default is to have one peak debt date per enterprise, just before the main income for that enterprise is received.

In an equilibrium model there is no start and end point. This complicates the calculation of interest because interest must be calculated for a given period. In AFO the interest period starts and finishes after the main income for the enterprise is received. This is logical from an expense point of view because the expense accumulates interest from the date it was incurred through to when the income associated with that cost is received. This ensures that expenditure is only incurred if the return exceeds the cost of interest.

Asset value is the value of all assets at the beginning of the interest period. The opportunity cost of investing in farm assets including livestock, machinery and infrastructure (sheds, yards etc) is captured in AFO. Asset value operates in conjunction with the interest to represent the opportunity cost of holding assets. Its role is to ensure that all assets that are selected have a return more than the interest cost, this ensures the optimal solution does not include assets that return less than investing the same money in a savings account (or to reduce core debt). This structure makes an equilibrium model generate a result similar to a multi-period model that accounts for the interest cost of money. Livestock flock structure is the main ‘decision’ that is altered by the inclusion of an asset value. For livestock, it ensures that the flock structure optimisation accounts for the opportunity cost of interest foregone from holding an animal till it is sold. Note: Main income is not receiving any interest because it is occurring at the end of the cashflow period (this is by definition because we are assuming that expenses are aimed at generating the “main income” - so the cashflow period starts just after the main income period and ends with the main income period). So the main income is earning interest for 0 days. Interest on Tactical income is just offsetting the asset cost, which can be thought of ‘stopping’ the asset cost at the point that the animal is sold. This means that the sale of the animal only needs to have generated enough income to justify the asset cost for a portion of the year.

The interest rate for credit and debit are different for farmers ‘real money’ in the bank. However, in AFO the same interest rate is used to represent debit and credit. The reasons are:

  1. Many farmers often have a core debt, so the farm cash position is usually negative even though their short term operating account may occasionally be positive. The differential interest rates are only justified if the farmer does not operate with a sweep facility to pay down core debt and then redraw when required later.

  2. As discussed above, the asset value and the cashflow operate together in the optimisation of flock structure. This implies that the interest rate for the cash flow should be the same as the discount rate for the asset value.

AFO tallies the total farm expenditure, adjusts it by a user defined return on expense factor and includes it in the objective to ensure the model achieves a minimum return on expenditure. The purpose of this is to represent farmer behaviour. It can also be used in the static equilibrium version to ‘fudge’ the risk associated with seasonal variation and reduce the optimal stocking rate to better align with on-farm values. The minimum rate of return on expenditure (MinROE) is specified by the user and can be turned off. The current rate in the static equilibrium model (25%) was calibrated by a comparison of the model output with on-farm benchmarking (e.g. Planfarm, 2022).

There is no representation of a starting cash balance. If it is included the model just selects the highest amount because that earns the most interest. The model can overdraw the working account if it needs cash, so this does not affect the model solution.

Tax is also not represented for several reasons:

  1. There are several mechanisms by which farmers seek to lessen their tax liabilities. Not all are ‘economically rational’ and not all are easily represented in a LP model.

  2. Many farmers nowadays invest in farm management deposits and income-averaging as a means of taxable income averaging and to smooth working capital borrowings. if the FMDs could be used ‘perfectly’ then each year would have the same taxable profit. Thus, the optimal farm management is unaffected by the inclusion of tax.

  3. AFO is a bioeconomic model with the aim of optimising farm management. It is not a finance model.

AfoLogic.Finance.f_cashflow_allocation(date_incurred, enterprise=None, z_pos=-1, c0_inc=False, is_phase_cost=False)

Allocates cashflow and wc to a season period and accounts for an interest component.

Cashflow allocation always has a length of 1. Meaning that cost is allocated based on the start date when it is incurred. Interest is calculated from this date until the end of the cashflow periods. The reason for not including a length is that cashflow for a give decision variable can not cross a node otherwise the child weather years do not incur the cashflow.

Working capital is tallied for each ‘main’ enterprise (controlled by user inputs). The working capital is accumulated from the most recent main income (across all enterprises) until the peak debt date for the given enterprise. E.g. in a typical mix farm system the stock working constraint tallys up the cashflow from just after harvest (most recent main income) until just before shearing (stock peak debt).

Parameters:

  • date_incurred – week of year when cashflow is incurred (must include z axis)

  • enterprise – enterprise. If no enterprise is passed in the cashflow is averaged across the c0 axis.

  • z_pos – axis position of z (must be negative e.g. reference from the end).

  • c0_inc – boolean stating if c0 axis is included in date_incurred

  • is_phase_cost – boolean stating if the cost is related to v_phase.

AfoLogic.Finance.overheads(params, r_vals)

Calculate overhead costs in each cashflow period and the associated interest.

Overheads are ongoing business expenses that are not directly attributed to creating a product or service. In AFO the user has the discretion to add, remove or alter the overheads that are including. Examples of overhead costs include; electricity, gas, shire rates, licenses, professional services, insurance and household expense.