Regional Farm Production

The important role of sheep in managing risk

Topics

• Farm Economics• Gross Margins• Risk• Cost of production

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?

Gross Margins

• Best tool to assess enterprise profitability?

• Who disagrees?

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

SW Slopes seasons

SW Slopes - drought year 2

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

Getting on top of costs

Know your cost of

production

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