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Sustainable Forest Management (SFM) Toolbox

Forest Finance

This module is intended to increase understanding among the managers of forest enterprises owned by communities, entrepreneurs or governments of the issues associated with the financing of sustainable forest management (SFM). It explains the concept of forest finance and provides an overview of financial requirements and the factors governing the financial needs of forest enterprises. The module outlines key challenges and suggests proactive responses to them, particularly those related to financial planning; economic monitoring; reducing costs; increasing earnings; and access to financing.

Forest finance contributes to SDGs:

The challenges of forest finance

Forest finance encompasses all the actions required to secure adequate financial resources for the ongoing management of a forest-based enterprise and to ensure its financial viability and profitability.

Forest enterprises require careful financial planning and sufficient financial reserves to cope with the many troughs in revenue inherent in forestry. Many forest operations are seasonal, for example, which means that revenue may not be collected evenly throughout the year. Forest harvesting may also be hampered by, for example, fire, bureaucracy or extreme weather events, posing further challenges to cash flow. It may take several years for an investment in a planted forest to start generating returns.

The many technical requirements of SFM increase the challenge of forest finance. Activities adding to the cost of SFM include: the preparation and planning of operations that meet SFM standards; the establishment of permanent infrastructure; monitoring; the purchase or leasing of equipment, including for harvesting, skidding and transport; the long-term management of the forest resource, including silvicultural operations and the protection of harvested areas; and, possibly, legality verification and certification. Other aspects of SFM, such as the protection of conservation set-asides, rare species and seed trees, imply the foregoing of potential income. There are also costs involved in the recruitment and training of staff capable of operating equipment and adhering to SFM guidelines, and, in the case of natural tropical forests, in the marketing of a wide range of species. Such SFM requirements increase the need for an adequate cash flow and therefore up-front financing; they also raise the risk for investors and therefore the difficulty of obtaining finance.

Small and medium-sized forest enterprises may particularly struggle to obtain adequate credit for their operations. For example, operations that require external services such as the preparation of management plans and their authorization, or the use of machines for skidding and transporting logs, often exceed the financial capacity of locally based operators.

What needs to be financed?

What needs to be financed?

Forest managers make investments in the following three broad categories:

  1. Initial investments to set up a forest enterprise or to make operations sustainable. The establishment of a planted forest or a natural-forest harvesting operation involves costs that are usually funded by loans, which in turn implies the creation of long-term liabilities that ultimately must be serviced with revenue generated by the enterprise.
  2. Expenditure incurred in regular forest operations funded by income derived from the sale of forest products.
  3. Replacement investment, such as to replace old machinery and other worn-out capital items, which must be financed by continuously aggregated savings made from the sale of forest products.

What influences the need for financing?

What influences the need for financing?

Expenditure generally increases with the size of the operation, and it is also influenced by the type, mode and intensity of the operation and the quality of management. The approach taken in dealing with disturbances in the production process (e.g. delays due to bad weather) has a particularly crucial effect on costs. In low-mechanized forest harvesting operations, labour (including social security contributions) is often the single biggest cost item. In more mechanized harvesting operations, the cost of machinery can account for up to 80 percent of total costs. Some enterprises subcontract certain operations, such as harvesting, to reduce the costs associated with directly employing staff and buying or leasing machinery, significantly changing the cost structure and financial flexibility of the enterprise. In many cases, transportation costs can also be substantial, depending on the distance to markets for labour, inputs, services and products.

Possibilities for action

Possibilities for action

The managers of forest enterprises need to know how much finance is needed, and when; how to access finance from various sources; and how to ensure that financial resources are available when they are needed. This requires careful planning. Operations should be designed in accordance with financial capacity, taking into account the estimated short-term and long-term cash flows. Efforts should be made to avoid overly optimistic estimates of cash flows and to carefully consider potential risks.

If, despite proper planning, the available financial resources and expected earnings are insufficient to finance a profitable operation, three potential actions may be taken:

  1. reduce costs by modifying the operation and finding efficiencies;
  2. look for financing at competitive interest rates from, for example, governments, banks and private enterprises; and
  3. increase earnings by diversifying products, improving marketing, and adopting alternative commercialization approaches (e.g. prices per assortment, negotiation, scaling, and contracts).

Managerial capacities

Managerial capacities

Financial management is a complex process, requiring skills and knowledge in, for example, law, administration, accounting, economics and marketing. Many enterprises lack some or all of these skills, and specialized professional services may need to be engaged. Small and medium-sized firms may find that participating in associations or cooperatives of similar enterprises (often referred to as producer organizations) can reduce the cost of such services for individual enterprises. In some countries, governments and non-governmental organizations also provide (or help fund) extension services or development programmes for forest enterprises engaged in SFM, including in forest financing.