What is driving my profitability
Author: Matthew Bryant (AgProfit) | Date: 07 Sep 2016
Introduction
It is a common perception that if only I can expand the farm then I will be more profitable. Reviewing the data in the Victorian Wimmera and Mallee over the past 20 years shows that farms have grown in size and income has more than doubled. However costs have also more than doubled so that the hoped for gains in efficiencies does not appear to be all that apparent. A relatively simple analysis of the farm profit margin and understanding the impact of key profit drivers can identify what areas are impacting profitability.The top profit performers within a region consistently operate with a higher operation profit margin than the group average. How do they do this? Management capacity is a key variable and good business outcomes tend to result for those who manage things well. As farms are increasing in size and scale in the Wimmera Mallee with the hope of being more profitable, this also serves to impact the risk profile of the business and make managing the farm more complex and challenging.
Dedicating time to establish, implement and update an effective business management framework can help mitigate the challenges of a more complex and time-hungry farm operation and position the business for better financial and social outcomes.
Farming trends in the Wimmera and Mallee (1996 – 2015)
From reviewing approximately 70 farm businesses in the Wimmera Mallee over the past 20 years, the following business performance trends can be observed (Figure 1 to Figure 4, Table 1):Note: Each farm business must have a minimum of 14 years to be included in the sample
Figure 1: Farm income versus costs (Wimmera Mallee). N.b. Bottom to top: overheads, machinery & labour costs, input costs and farm finance costs. (Source: Ag Profit)
Table 1: Average farm costs as $/ha (Wimmera Mallee). (Source: Ag Profit)
Year Period | Average Farm Costs ($/Ha Croppable Area) |
---|---|
1996-2000 | 260 |
2001-2005 | 290 |
2006-2010 | 340 |
2011-2015 | 470 |
Figure 3: Farm land area (top line) versus crop intensity (bottom line) (Wimmera Mallee). (Source: Ag Profit)
Key observations
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The average farm business in the Wimmera and Mallee has doubled turnover and costs over the last 15 years.
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There has not been any consistent increase in profit over this period as the business scale has increased.
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Average farm debt has increased significantly however market value of equity (including capital gain of land value) has remained relatively consistent.
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Average size of farm croppable land has increased by over 50 per cent over 20 years and cropping intensity has increased by 15 per cent.
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The value of machinery working the farm croppable land area has more than doubled over the last 20 years.
Farm profit and cost classification
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Input costs (such as chemicals, fertiliser, seed, fodder, irrigation electricity).
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Machinery and labour costs (such as fuel, repairs, depreciation, contractor costs, wages, super and imputed family labour; to compensate for drawings paid to family members rather than receiving a wage).
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Overheads (such as professional fees, insurance, rates, utilities and depreciation of improvement assets).
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Finance costs (such as interest and land and machinery lease costs).
Figure 5: Farm profit and cost classifications.
These costs can be analysed as a ratio to the farm income produced to determine the impact each key cost area has on the business profit margin.
Profit margin
The business profit margin measures how much of the income generated is retained as profit and is expressed as a percentage of the income. There can only be a 100 per cent of the income allocated to costs before a loss results. However we are hoping that we do not allocate a 100 per cent of the income to costs as we want to retain some as profit.
Ag Profit uses the following guidelines to provide an assessment as to how the cost areas are consuming profit and thus reducing available profit (Table 2).
Note the guidelines have been assessed by looking at data over a long period of time. They may be a bit out for certain years (i.e. really good or bad production years) or not quite matched for certain farming regions (i.e. a really good farming area should have a higher profitability capacity than a not so good farming area).
Table 2: Profit margin and profit driver guidelines. (Source: Ag Profit)
Key Performance Indicator | Units | Weak | Medium | Strong | Guideline |
---|---|---|---|---|---|
Profitability | |||||
Farm Profit Margin | as % Farm Income | < 3.0% | 3.0% - 17.0% | > 17.0% | 10.0% |
Farm Operating Profit Margin | as % Farm Income | < 15.0% | 15.0% - 25.0% | > 25.0% | 20.0% |
Farm Profit Drivers | |||||
Input Costs | as % Farm Income | > 30.0% | 30.0% - 22.0% | < 22.0% | 26.0% |
Machinery & Labour Costs | as % Farm Income | > 50.0% | 50.0% - 40.0% | < 40.0% | 45.0% |
Overheads | as % Farm Income | > 11.0% | 11.0% - 7.0% | < 7.0% | 9.0% |
Finance Costs | as % Farm Income | > 14.0% | 14.0% - 6.0% | < 6.0% | 10.0% |
Profit drivers - top profit group versus average in the Wimmera (2010 – 2015)
Hence over this period the total amount expended on costs (as a ratio of the income) and hence the respective profit margins are shown in Figure 7.
Figure 7: Farm cost and profit margin (Wimmera 2010 – 2015). (Source: Ag Profit)
Figure 8 shows the profit drivers over this period.
Framework characteristics of good business management
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Price takers and not price makers.
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Uncertainty regarding production yield; more especially for broadacre cropping.
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Large delay between when costs are expended and income received; again particularly for broadacre cropping.
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Farming work is away from population centres; smaller density of available workforce.
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Strategic outcomes – perhaps the five year plan.
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Tactical outcomes – achieving seasonal objectives.
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Operational outcomes – day to day/week to week needs and activities.
Staff productivity
Strategic |
Establish staff HR policies and procedures, including:
Transition/succession strategy
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Tactical | Review policy annually
Undertake staff review
Find out what motivates each individual – how to keep them motivated and enthusiastic
Investigate, plan and discuss training options
Social activities
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Operational | Run staff meetings
Reward good performance – praise when deserved
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Farm productivity
Strategic | Enterprise selection and risk strategy (more livestock less crop etc.)
Synergistic enterprise opportunities
Soil health
Weed, pest and disease management longer-term plans
Paddock size and structure
Grain logistics
Monitor and review – gross margins and whole of business benchmarking
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Tactical | Crop/livestock budget and inputs program planning
Soil sampling strategy
Machinery maintenance plan
Schedule contractor involvement
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Operational |
Timely implementation of crop/livestock plan activities
Effective weed/pest/disease monitoring and paddock assessments
Remove fences
Soil sampling
Complete data recording |
Marketing/sale price
Strategic | Establish marketing policy, including:
On-farm storage plan
Understand available hedging options
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Tactical | Review seasonal forecasts and markets on regular basis
Maximise buyer/seller networking relationships
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Operational | Make decisions using agreed criteria (avoid rushed decisions when tired) |
Machinery
Strategic | Longer-term planning requirements – machinery/contractor mix
Alternative options for generating income (i.e. contracting)
Asset purchase business case justification
Operating procedures
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Tactical | Machinery maintenance plan Staff training for machinery use (document)/review operating procedures Spare parts inventory |
Operational | Thorough maintenance
Update operating procedures
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Engaging contractors
Strategic | Longer-term planning requirements – machinery/contractor mix
Establish contractor engagement agreement, including:
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Tactical | Review/rate contractor criticality - what are the consequences if they are late?
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Operational | Implement contractor engagement agreement
Communicate with contractors as required to ensure optimum arrival
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Finance costs
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What can I do to reduce my interest rate risk margin?
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Review alternatives funding source options.
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Negotiate with competitive tension to drive better outcomes.
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Plan to pay off principal.
Overheads
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Insurance review (life insurance, accident and trauma, multi-peril and crop).
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Professional fee review.
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Utility pricing review/alternatives.
Cash flow (the lifeblood of business activity)
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Do I manage a detailed budget for cash flow planning throughout the season?
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Do I monitor the budget with cashbook actuals?
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Is access to working capital guaranteed?
Off-farm diversification
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Am I able to afford to diversify off-farm?
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Do I have an interest in other investment areas?
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Need for business case justification.
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How to best assess the risk when not that familiar with the asset class?
Management framework
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Who are the participants in the management team?
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What role can advisers play; can I use them more (in different ways) to help me manage the business?
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When and how often should we meet?
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Where should we meet?
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Note taking and follow-up action management.
Beware the accumulation of incremental cost increases
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Council rates,
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insurance,
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some professional fees,
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inputs,
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machinery servicing, and;
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wage (and super) rises.
Other considerations
How profitable is the farm if market rate for land access is applied?
Contact details
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