Regional Farm Production
The important role of sheep in
managing risk
Topics
•
•
•
•
Farm Economics
Gross Margins
Risk
Cost of production
Business analysis
Small owner-operated businesses
Comparison between farm and non-farm businesses
Benchmark
Profit per working owner
Profit per owner workhour
Debt/income ratio
Debt, depreciation, lease & HP
Fixed costs as % income 1
Owners equity/total assets
Farm
Non-farm
$22,776
$94,211
$11.44
$43.42
12.3%
2.00%
27.40%
3.50%
92.60%
44.37%
83.51%
40.63%
Non-farm
as % farm
414%
380%
16%
13%
48%
49%
Economics 101
Variable costs are spent per tonne or per
head
Grain treatment
Contract costs
Vet costs
about 5-10% of costs
Economics101
Variable costs are spent per tonne or per head
Fixed costs are spent per hectare or per farm
Fertiliser
Chemical
Rates
Labour
Machinery
Admin
Finance
about 70% of costs
Farm Economic Model
Breakeven
point
$
Direct Costs
•Crop inputs
•Fodder
•Animal health
Overheads
• Admin
• Labour
• Finance
Units
•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?
Gross Margins
• Best tool to assess enterprise profitability?
• Who disagrees?
STOP
Gross 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 iceberg
Graphical representation of costs included in financial indicators
SW Slopes farm, 60% crop
Costs per hectare
Crop & Pasture Costs
Chemical
Contract
Crop Insurance
Fertiliser
Seed
Supplies & Grain Purchased
Other
Livestock Costs
Agistment & Rations
Animal Health & Veterinary
Fodder
Freight
Purchases
Shearing & Crutching
Other
Variable costs
Machinery (incl. depreciation)
Labour
Overheads
Interest
Fixed Costs
Total Costs (including depreciation)
Capital costs
Drawings & Tax
Gross margin
134.99
36.29
21.14
7.44
49.53
20.58
0.00
0.00
107.52
8.65
4.62
1.99
0.00
1.17
4.69
4.69
242.50
132.32
27.70
87.32
93.54
Costs included in
Profit
$243
340.88
501.67
28.00
$243
$243
$341
$341
$28
$64
63.66
Total costs included, $/ha
Percentage of total costs
COP
$243
36%
$583
86%
$675
100%
Comparing gross margins and cash
margins
Six-year average gross margin
50th price percentile
stable production period
1,000,000
450
400
350
300
$ 250
/
200
h
a 150
$
500,000
c
a
s
h
0
50
m -500,000
a
r
g
-1,000,000
i
n
0
-1,500,000
100
-50
Six-year cash margin
50th price percentile
stable production period
Beyond Gross Margins
Beyond 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
40,000
40,000
80,000
75,000
80,000
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?
Predicted wheat yield kg/ha
Birchip 100 years
6000
5000
4000
Yield
kg/ha/yr
3000
2000
1000
1900
1905
1910
1915
1920
1925
1930
1935
1940
1945
1950
1955
1960
1965
1970
1975
1980
1985
1990
1995
2000
0
Variability buffered by:
Grazing
Price
Poor management
Variability amplified by:
Cropping
Compounding interest
Income tax
Good management
Climate change
SW Slopes – average years
36 month cash flow
Decile 5 rainfall, 60% decile prices
$800,000
$600,000
$200,000
SW Slopes 30%
SW Slopes 60%
SW Slopes 100%
-$400,000
-$600,000
May-10
Mar-10
Jan-10
Nov-09
Sep-09
Jul-09
May-09
Mar-09
Jan-09
Nov-08
Sep-08
Jul-08
May-08
Mar-08
Jan-08
Nov-07
-$200,000
Sep-07
$0
Jul-07
Bank balance
$400,000
SW Slopes – drought year 2
36 month cash flow
Decile 5 rainfall, year 2 drought, 60% decile prices
$800,000
$600,000
$200,000
SW Slopes 30%
SW Slopes 60%
SW Slopes 100%
$0
May-10
Mar-10
Jan-10
Nov-09
Sep-09
Jul-09
May-09
Mar-09
Jan-09
Nov-08
Sep-08
Jul-08
May-08
Mar-08
Jan-08
-$600,000
Nov-07
-$400,000
Sep-07
-$200,000
Jul-07
Bank balance
$400,000
Riverina cash flow – average
years
36 month cash flow
Decile 5 rainfall, 60% decile prices
$800,000
$600,000
Bank balance
$400,000
$200,000
Riverina 30% crop
$0
Riverina 60% crop
Riverina 100% crop
-$200,000
-$400,000
-$600,000
-$800,000
Riverina cash flow – drought
year 2
36 month cash flow
Decile 5 rainfall, drought year 2, 60% decile prices
$800,000
$600,000
Bank balance
$400,000
$200,000
Riverina 30% crop
$0
Riverina 60% crop
Riverina 100% crop
-$200,000
-$400,000
-$600,000
-$800,000
Riverina accumulated cash flow
Effect of climate variation
Effect of rainfall scenario on cash flow
Riverina, price 60% percentile
Stocking rate 75% potential
Accumulated cash flow
1500000
1000000
30% crop
60% crop
500000
100% crop
0
-500000
-1000000
1,1,1
3,3,3
5,5,5
Rainfall scenario, deciles GSR
7,7,7
Riverina accumulated cash flow
Drought year 2
Effect of rainfall scenario on cash flow
Riverina, price 60% percentile, drought year 2
Stocking rate 75% of potential
1500000
Accumulated cash flow
1000000
30% crop
60% crop
500000
100% crop
0
-500000
-1000000
1,1,1
3,1,3
5,1,5
Rainfall scenario, deciles GSR
7,1,7
SW Slopes seasons
SW Slopes - drought year 2
Effects of risk
20 year run on Junee farm
Junee data 1990-2007
Profit
Profit Crop
Profit Sheep
Probability
Average
of loss annual profit
24%
112,760
34%
22,285
0%
48,971
It’s all about minimising losses, not maximising profits
SD
120%
572%
31%
Getting on top of costs
Know your cost of
production
Why are costs important?
Index of rural commodity costs and prices
180
160
1
9
9
8
v
a
l
u
e
s
Prices
paid
140
120
Prices
received
100
80
Terms of
trade
60
40
20
0
Reserve Bank of Australia Series G05; ABARE 2008
Costs are inflexible
Variable costs are spent per tonne
Fixed costs are spent per hectare
Fixed costs as percent income
100.0%
90.5%
94.7%
90.0%
76.3%
80.0%
70.0%
62.4%
60.0%
50.0%
40.0%
30.0%
20.0%
16.6%
22.1%
10.0%
0.0%
Domestic Real Estate Pharmacy Consultant Wimmera
Appliance
Engineers
Farm
Retailing
Mallee
Farm
Cost of production
COP = total cash costs
area used
= $520/ha to $650/ha for Junee
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•
•
•
Easy to work out
Overcomes most of the problems of gross margins
Contains all the costs
Makes break-even easy to calculate
Cost of production
Whole farm $/ha
Cost of Production $/ha
$800
$685
$700
$630
$604
$600
$498
$500
$582
$550
$544
$483
$548
$530
$496
$480
Riverina
SW Slopes
$400
$300
$346
$251
$259
$248
$264
Mallee
$327
$288
$254
$281
$295
$309
$271
$200
$100
$0
Av. Years
Drought
Av. Years
Drought
Av. Years
Drought
30% crop
30% crop
60% crop
60% crop
100% crop
100% crop
Western Vic
Enterprise cost of production
Decile 5 rainfall, 60% price decile, drought year 2
$900
$800
$705
$/ha costs
$700
$571
$558
$600
$500
$408
$400
$300
$200
$100
$0
$275
$257
$282
$306
30% crop
60% crop
100% 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