Applying business management principles and decision tools to optimise the enterprise mix

| Date: 14 Jun 2008

Philip O’Callaghan. Business advisor and coach to Broadacre crop/livestock managers in South Eastern Australia, based in Bendigo, Victoria.

Grain prices at 2007/08 levels provide an opportunity to increase crop intensity and production with a reduced financial risk and higher financial reward, however cost control and monitoring remains the key to business success.

The new found world demand for energy and the increasing affluence in Asia, has the potential to lift the Australian Economy in a similar way to that of the current mining/resource boom.
 
The increased demand for food and energy has increased prices resulting in the potential for strong profits in 2008 and beyond. However higher cost of inputs for fertilizer, sprays and fuel will increase the financial risk. Financial risk is about managing costs in proportion to income variability, and continues to drive Best Practice in modern Farming Systems.
 
Decision Support Tools help farm business mangers to determine their financial risk and exposure.
These tools include:
  • Whole of business Benchmarks
  • Enterprise Analysis benchmarks
  • Seasonal and commodity price forecasts
  • Budgeting and ‘what if’ scenarios
  • Risk Tool for personal risk profiles
 
Seasonal and commodity price forecasts are improving however in 2008 are not reliable for key decision making. Hence budgeting should include ‘what if’ scenarios such as comparison of crop mix and crop intensity. An example ‘what if’ scenario follows and shows the comparison of 90% crop to 65% crop intensity.
 
Table 1: Assumptions

 
Yield t/ha
 
Price $/t
 
Costs $/ha
 
Cereals
Oilseed/Legumes
Cereals
Oilseed/legumes
Whole Business
90% Crop
3.0
1.5
240
450
560
65% Crop
3.0
1.5
240
450
450
 


 
 
 
 
 
 
 
 
 
 
 
 
 
 
 

Legend:
Green            = 90% crop
 
Orange         = 65% Crop

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
763
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
700
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
640
 
 
 
 
 
 
 
203
 
 
 
 
 
 
 
80
 
 
 
 
 
 
 
 
 
592
 
 
 
600
 
 
 
 
 
 
 
 
 
 
 
 
 
90% Breakeven
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
$/ha
 
 
 
 
 
 
-51
 
 
 
 
 
142
 
 
 
500
 
 
 
498
 
509
 
 
 
 
 
 
 
 
 
 
 
 
 
48
 
 
 
 
 
 
 
 
 
65% Breakeven
 
 
 
 
 
 
 
 
 
-46
 
 
 
 
 
 
 
400
 
 
 
 
 
 
 
404
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Budget
 
 
Income Down 20%
 
 
Income Up 20%
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Figure 1: Comparison of income and profit/loss for 90% crop to 65% crop intensity
 
For a 1,000 hectare farm and at the budgeted yields and prices, then the above is summarised as:
·         65% crop achieves a  $110,000 reduction in total costs
·         90% crop makes $170,000 extra profit in good years
·         Both crop options make similar losses in poor years
 
NOTE: Over the last 10 years the actual income achieved was less than the ‘Income Down 20%’. At previous lower prices the lower crop intensity achieved better overall returns. However at higher grain prices, targeting farming systems with higher income, has the potential for higher profits.
 
Since 1980’s growth in farm profit has been maintained. Other variables can be summarized as follows:
Table 2: Change since the 1980’s
 
Average per year
Land Values
5.5%
Farm Debt
12%
Farm Production Value
7%
Crop Intensity
5%
Farm Costs
4%
Farm Profit
No change
 


 
Farm Profits can be monitored using Decision Support Tools as follows:

1. ORM Business Health Indicators- 10 year Averages

Table 3: ORM Business Health Indicators
Profit Drivers
Unit
ORM Guideline
Water Use Efficiency
 
 
Cropping- Crop more than 80%
$/ha/100mm
80-120
Mixed- Crop less then 70%
$/ha/100mm
50-90
Less costs
 
 
Farm Input Costs
% to Farm Income
40-30
Machinery Costs
% to Farm Income
30-20
Labour Costs (includes all labour)
% to Farm Income
25-15
Financing Costs
% to Farm Income
12-5
Surplus
% of Farm Income
10-20
 

2. Whole of Business Key Performance Indicators (KPI’s) provide an overview of success.

These KPI’s can be summarized as:
Table 4: KPI’s
(10 year average)
Unit
ORM Victorian
Average
ORM Victorian
Top 20%
Return on Capital
%
4.0
9.5
Change in Net worth
$/Business
125,000
270,000
Farm Profit (after all labour and interest)
$/Business
43,000
227,000
 
Individual performance in KPI’s will vary according to:
 

1) Business Life Cycle

Figure 2: Business Life Cycle


 

2) Seasonal Variations

Figure 3: Rainfall vs. Yield- Australia, ABARE
 

3) Others

·         Commodity price
·         Cost of Inputs
·         Climatic events such as timing of the Autumn break
·         Management Skills
·         Available resources of labour and machinery

3. Profit to wealth converters

What we do with the profits is also important. Converting Profits into equity Growth (Wealth) can be prioritized when discussing with your Accountant/Financial advisors as follows:
 
Figure 5: Converting Profit into wealth
 
Characteristics of a successful Business can be outlined as:
·         Detailed record-keeping and financial reporting
·         Reliable profits relative to Income
·         Diversification within the business, i.e. mix of enterprises
·         Growing asset wealth in both business and non-business
·         Financial Buffers to cover Income volatility
·         Professional attitude
·         A recognised need for external advisors in areas where skills are limited

4. Actions

Good decisions are informed are researched. Use Decision Support Tools as exampled in this paper to help find your ‘Optimum Enterprise Mix’. The mix will vary according to current circumstances, hence requires regular reviews and fine tuning. Be prepared to change as your farming environment changes.

Contact details

Philip O’Callaghan
Managing Director, Business Coach
ORM Bendigo
Telephone: 03 54 416 176
FAX: 03 54 444 299