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Business analysisSmall owner-operated businesses
Comparison between farm and non-farm businesses
Benchmark Farm Non-farmNon-farm
as % farmProfit per working owner $22,776 $94,211 414%Profit per owner workhour $11.44 $43.42 380%Debt/income ratio 12.3% 2.00% 16%Debt, depreciation, lease & HP 27.40% 3.50% 13%
Fixed costs as % income 1 92.60% 44.37% 48%Owners equity/total assets 83.51% 40.63% 49%
Economics 101
Variable costs are spent per tonne or per head
Grain treatment
Contract costs about 5-10% of costs
Vet costs
Economics101
Variable costs are spent per tonne or per head
Fixed costs are spent per hectare or per farm
Fertiliser
Chemical
Rates
Labour about 70% of costs
Machinery
Admin
Finance
Units
$
Overheads• Admin• Labour• Finance
Direct Costs• Crop inputs• Fodder• Animal healthDeficit
Total costs
Breakeven point
Farm Economic Model
Turnover
Surplus• Growth• Drawings• Investment
Economics101
Variable costs are the costs of producing an item
Fixed costs are the costs of maintaining the workforce
Capital costs are the reward for good management
Living costs to fund the current living standard
20%
Investment to create wealth for the future
Economics101
Variable costs are spent per tonne or per head
Fixed costs are spent per hectare or per farm
• Variable costs are the costs of producing an item• Fixed costs are the costs of maintaining the workforce• Capital costs are the reward for good management
Which is the most important?
STOPGross margin analysis is dangerous
• Gross margin are always positive• They do not allow for risk• They account for less than 40% of costs• They do not allow for the variable part of
fixed and capital costs (labour, machinery, finance) – divisional costs
• They mask affordability
Gross margins are the tip of the iceberg
The tip of the icebergGraphical representation of costs included in financial indicators
SW Slopes farm, 60% cropCosts per hectare Gross margin Profit COP
Crop & Pasture Costs 134.99Chemical 36.29Contract 21.14Crop Insurance 7.44Fertiliser 49.53Seed 20.58Supplies & Grain Purchased 0.00Other 0.00
Livestock Costs 107.52Agistment & Rations 8.65Animal Health & Veterinary 4.62Fodder 1.99Freight 0.00Purchases 1.17Shearing & Crutching 4.69Other 4.69
Variable costs 242.50 $243 $243 $243Machinery (incl. depreciation) 132.32Labour 27.70Overheads 87.32Interest 93.54
Fixed Costs 340.88 $341 $341
Total Costs (including depreciation) 501.67
Capital costs 28.00 $28 Drawings & Tax 63.66 $64
Total costs included, $/ha $243 $583 $675Percentage of total costs 36% 86% 100%
Costs included in
Comparing gross margins and cash margins
APNAPY
PPNPPY
APCN
APCY
PPCN
PPCY-50
0
50
100
150
200
250
300
350
400
450
Six-year average gross margin 50th price percentile
stable production period
$/ha
APNAPY
PPNPPY
APCN
APCY
PPCN
PPCY-1,500,000
-1,000,000
-500,000
0
500,000
1,000,000
Six-year cash margin 50th price percentile
stable production period
$ cash
margin
Beyond Gross MarginsBeyond Gross Margins
Cattle Division Farming Division Sheep Division
Enterprise Cows Steers Canola Wheat Wool Lambs
Gross Product 50,000 100,000 90,000 80,000 100,000 120,000
- Direct Costs 10,000 20,000 50,000 40,000 20,000 45,000
= Gross Margin 40,000 80,000 40,000 40,000 80,000 75,000
Division Gross Margin 120,000 90,000 155,000
- Division Overheads 40,000 80,000 50,000
= Division Profit/Loss 80,000 10,000 105,000
Property Gross Margin 195,000
- Business Overheads & Cap 60,000
= Operating Profit (Loss) 135,000
What are divisional overheads?• Interest & capital on equipment• R&M on equipment• Super on stock pasture• Additional labour units
RISK
Risk is defined as the chance of financial loss
• Risk is the defining feature of dryland farming
• Climatic risk is the most important variable
How do you deal with this amount of risk?
0
1000
2000
3000
4000
5000
6000
1900
1905
1910
1915
1920
1925
1930
1935
1940
1945
1950
1955
1960
1965
1970
1975
1980
1985
1990
1995
2000
Yieldkg/ha/yr
Predicted wheat yield kg/haBirchip 100 years
Variability buffered by:GrazingPricePoor management
Variability amplified by:CroppingCompounding interestIncome taxGood managementClimate change
SW Slopes – average yearsJu
l-07
Se
p-0
7
No
v-0
7
Jan
-08
Ma
r-0
8
Ma
y-0
8
Jul-0
8
Se
p-0
8
No
v-0
8
Jan
-09
Ma
r-0
9
Ma
y-0
9
Jul-0
9
Se
p-0
9
No
v-0
9
Jan
-10
Ma
r-1
0
Ma
y-1
0
-$600,000
-$400,000
-$200,000
$0
$200,000
$400,000
$600,000
$800,000
36 month cash flow Decile 5 rainfall, 60% decile prices
SW Slopes 30%
SW Slopes 60%
SW Slopes 100%
Ba
nk
ba
lan
ce
SW Slopes – drought year 2
Jul-0
7
Se
p-0
7
No
v-07
Jan
-08
Ma
r-08
Ma
y-08
Jul-0
8
Se
p-0
8
No
v-08
Jan
-09
Ma
r-09
Ma
y-09
Jul-0
9
Se
p-0
9
No
v-09
Jan
-10
Ma
r-10
Ma
y-10
-$600,000
-$400,000
-$200,000
$0
$200,000
$400,000
$600,000
$800,000
36 month cash flow Decile 5 rainfall, year 2 drought, 60% decile prices
SW Slopes 30%
SW Slopes 60%
SW Slopes 100%
Ba
nk
ba
lan
ce
Riverina cash flow – average years
-$800,000
-$600,000
-$400,000
-$200,000
$0
$200,000
$400,000
$600,000
$800,000
Ba
nk
ba
lan
ce
36 month cash flow Decile 5 rainfall, 60% decile prices
Riverina 30% crop
Riverina 60% crop
Riverina 100% crop
Riverina cash flow – drought year 2
-$800,000
-$600,000
-$400,000
-$200,000
$0
$200,000
$400,000
$600,000
$800,000
Ba
nk
ba
lan
ce
36 month cash flow Decile 5 rainfall, drought year 2, 60% decile prices
Riverina 30% crop
Riverina 60% crop
Riverina 100% crop
Riverina accumulated cash flowEffect of climate variation
-1000000
-500000
0
500000
1000000
1500000
1,1,1 3,3,3 5,5,5 7,7,7
Rainfall scenario, deciles GSR
Accu
mul
ated
cash
flow
Effect of rainfall scenario on cash flow Riverina, price 60% percentileStocking rate 75% potential
30% crop
60% crop
100% crop
Riverina accumulated cash flowDrought year 2
-1000000
-500000
0
500000
1000000
1500000
1,1,1 3,1,3 5,1,5 7,1,7
Rainfall scenario, deciles GSR
Accu
mul
ated
cash
flow
Effect of rainfall scenario on cash flow Riverina, price 60% percentile, drought year 2
Stocking rate 75% of potential
30% crop
60% crop
100% crop
Effects of risk 20 year run on Junee farm
Junee data 1990-2007 Probability
of loss Average
annual profit SDProfit 24% 112,760 120%Profit Crop 34% 22,285 572%Profit Sheep 0% 48,971 31%
It’s all about minimising losses, not maximising profits
0
20
40
60
80
100
120
140
160
180
1998
values
Index of rural commodity costs and prices
Prices paid
Prices received
Terms of trade
Reserve Bank of Australia Series G05; ABARE 2008
Why are costs important?
Costs are inflexibleVariable costs are spent per tonneFixed costs are spent per hectare
16.6%
76.3%
22.1%
62.4%
90.5% 94.7%
0.0%
10.0%
20.0%
30.0%
40.0%
50.0%
60.0%
70.0%
80.0%
90.0%
100.0%
Domestic Appliance Retailing
Real Estate Pharmacy Consultant Engineers
Wimmera Farm
Mallee Farm
Fixed costs as percent income
Cost of production
COP = total cash costs
area used
= $520/ha to $650/ha for Junee
• Easy to work out• Overcomes most of the problems of gross
margins• Contains all the costs• Makes break-even easy to calculate
$251 $248$288
$254$295
$271
$544
$483
$604
$548
$685
$582
$259 $264
$346
$281
$327 $309
$498 $480
$550
$496
$630
$530
$0
$100
$200
$300
$400
$500
$600
$700
$800
Av. Years Drought Av. Years Drought Av. Years Drought
30% crop 30% crop 60% crop 60% crop 100% crop 100% crop
Cost
of P
rodu
ction
$/h
a
Cost of production Whole farm $/ha
Riverina
SW Slopes
Mallee
Western Vic
$275 $257
$705
$558
$282 $306
$571
$408
$0
$100
$200
$300
$400
$500
$600
$700
$800
$900
$/ha
cost
s
Enterprise cost of productionDecile 5 rainfall, 60% price decile, drought year 2
30% crop60% crop100% crop
Calculating break-even
• Break-even yield = COP/price
= $500/ $230
= 2.17 t/ha
• Break-even price = COP/yield
= $500/ 1.1 t/ha
= $455
How do we lock in a margin?
• Set goals (living standards, wealth, succession) WOTB
• Minimise risk at all times• Concentrate on fixed costs• Forget gross margins• Use cost of production & cash flow for planning
Aim to minimise losses, not maximise income – consistent profitability