How does the timing of capital affect coffee farmers?
As with any agricultural commodity, capital and access to finance are essential for coffee farmers. Moreover, access to capital becomes even more important when we consider that some producers have been facing financial challenges for many years.
Coffee is a seasonal product, which means that it is harvested at a certain time every year. In turn, coffee producers are usually paid in a lump sum once a year when they sell their harvest.
Ultimately, this model creates a lot of instability for some farmers, as it can be difficult to financially plan for the year ahead.
To learn more about the timing of capital and how it impacts coffee producers, I spoke to four industry experts. Read on for more of their insight.
You may also like our article on how access to finance can be improved for smallholder coffee farmers.
What is capital?
In simple terms, “capital” is a term used to describe cash or financial assets which are held by a business or an individual. These assets are then used to operate the business, or expand its operations.
A coffee farm sells goods, and is therefore a business. By selling coffee, producers generate money, with the aim of turning a profit which can be invested back into their business. Investment can take a number of different forms, including:
- Replacing ageing coffee plants
- Planting more resilient varieties
- Repairing or replacing equipment and machinery
- Installing irrigation systems
- Buying new types of fertiliser
Coffee farmers rely heavily on the success of their harvests to generate capital and obtain access to finance. So how do they receive payment?
How are coffee farmers paid?
Luis Alberto Cuellar is a co-founder of Promising Crops. He explains that farmers are generally paid annually in a lump sum after they sell their coffee.
“The time of harvest largely determines when the end product (or coffee) will be delivered and sold,” he says. “Very few coffee producers can afford to hold their coffee and sell it after the harvest season, although this model does work in some countries like Brazil.”
Luis also notes that farmers are paid when a local buyer purchases their coffee.
“The final product can come in several forms,” he says. “Farmers can sell cherry, wet and/or dry parchment, or green coffee.
“The type of coffee sold mostly depends on the region or country, as well as the mechanisms which local buyers use,” he adds.
Moreover, the prices which farmers receive (also known as the farmgate price) typically doesn’t cover a number of additional costs which some farmers have to absorb, such as milling, transportation, or exportation fees.
In turn, farmers often receive a lower price than what was paid at processing mills or to coffee traders. Ultimately, this means farmers are generally unable to retain as much value as possible.
Why do coffee farmers need access to finance?
Compared to other businesses in the coffee supply chain, producers don’t typically hold much capital at any given time – especially smallholder farmers. This can lead to a number of challenges, including investing in farming inputs such as fertilisers and new equipment, as well as efforts to improve coffee quality.
Herbert Peñaloza Correa is the Director of Operations at 575 Café.
“Having access to finance equips you to leverage all necessary resources to operate a farm,” he explains. “For example, if you want to successfully plant a new field of coffee, you need at least US $5,000 per ha.
“Furthermore, it will take at least three years of successful harvests to recoup that investment,” he adds. “For newer coffee farmers, you also have to buy land and invest in infrastructure, but many producers don’t have the financial resources to do so.”
Capital can cover more immediate, short-term needs, as well as mitigating the risk of unforeseen circumstances. These can include an unpredicted loss in yields or extreme weather conditions which affect harvesting.
In coffee production, financial resources such as credit facilities and loans can also cover long-term needs, as Luis explains:
“In countries like Colombia, coffee farmers have access to finance models to establish farms, build facilities, and purchase new equipment,” he says. “There are also farm renewal programmes, which are available every seven years.”
However, not every origin country has similar financial support, which leads some producers to obtain credit facilities or loans from banks.
Willem Boot is the founder and CEO of Boot Coffee. He explains how this can lead to a number of issues.
“These loans typically have high interest rates,” he tells me. “In the case of smallholder farmers who don’t own land, they don’t have any collateral for a loan, [which can make accessing one difficult].”
Why is the timing of capital so important?
Finance can provide the necessary working capital to cover the costs associated with coffee production, which can help to improve a farm’s efficiency and profitability.
However, the timing of receiving capital can often be sporadic, which makes both short term and long term planning difficult. Herbert explains some of the ways in which farmers can receive payment in Colombia:
- Payment is made promptly upon delivery if producers sell coffee based on the daily C market price
- If they sell to a coffee dealer or trader, the payment can take up to a few months after the delivery of coffee
- Producers receive payments in advance if they are a member of a co-operative
Ultimately, the type of agreement depends heavily on who is selling and who is buying coffee. For example, larger buyers will typically dictate whether payments are made upfront or later on.
Planning for the future
If a farmer does not receive payments upfront, they may find it more difficult to plan for the months and years ahead. This is especially concerning when you consider that many producers already have to work with one lump sum – rather than regular weekly or monthly income – for up to a year. This can present a number of challenges if urgent repairs or maintenance costs arise throughout the year.
Willem says that between 70% and 80% of the world’s coffee producers are smallholders. This makes finance difficult to come by, for all the aforementioned reasons. As a result, this means that the majority of the world’s coffee farmers are unable to leverage capital to reinvest in their farms.
Not only does this mean that producers aren’t able to invest in the quality or yield of their coffee plants, but it can also mean that they aren’t earning a stable living income – impacting their and their family’s livelihoods.
What about direct trade models?
Willem says that opportunities to engage in direct trade can create risks for some smallholder farmers who have little capital or access to financial resources. Ultimately, without a financial safety net, some farmers aren’t able to hold onto their coffee to wait to receive higher prices.
“It’s like a tradeoff,” he explains. “A coffee farmer may not have the time to wait for the best possible price from the best possible buyer.”
Is pre-financing a long-term solution?
Pre-financing is when a producer takes out a loan to cover costs in advance over a fixed period of time before they receive payment from a buyer.
Access to pre-financing can vary depending on the producing country, or even the farm. Willem explains that with bigger farms in countries like Ethiopia, it’s common for banks to finance infrastructure investments on a farm. With this model, a coffee farmer will pre-invest 30% of total costs themselves, while the bank will finance the remaining 70%.
Some coffee producers may also establish relationships with lenders or investors who are willing to pre-finance their operations on a regular basis. However, it’s important to note that not all farmers have equal access to this opportunity, especially smallholders who might not have access to the necessary cashflow or collateral.
Willem believes that one of the most sustainable, long-term solutions is to provide training for farmers so they can better understand how financial structures in coffee production work. In turn, Willem says this can better mitigate risks and enable producers to make more informed decisions, too.
Judith Ganes is the founder and president of J. Ganes Consulting. She explains that crop diversification can be a way for farmers to improve capital.
“In Brazil, many coffee farmers also plant black pepper, mango, and soybeans to provide additional income,” she says. “For instance, soybeans can be harvested and sold after five months.
“Growing coffee requires a three-year investment, so there is ultimately more risk,” she adds.
As with any business, the timing of capital plays a crucial role in how a coffee farm operates. Moreover, it has a big impact on its profitability and financial success, too.
When we discuss how we can make the coffee industry more sustainable, it’s clear that rethinking how and when coffee farmers are paid should be an integral topic for the future.
Enjoyed this? Then read our article on why affordable finance is so important for coffee producers.
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