Turning advice into profit - The opportunities

Author: | Date: 26 Mar 2013

Phil O’Callaghan,

ORM Pty Ltd

Take home messages

  • Over the last 10 years farm income per hectare increased about 50 %, however it is offset by an increase in cost per hectare of crop inputs, machinery and finance.
  • Businesses that manage income volatility have the opportunity for strong business profits.
  • There is no 'one size fits all'. Farmers have diverse needs and therefore require tailored advice.

 

Background

Despite climate variability and a run of dry seasons, grain growers have continued to find ways to maintain profits through investment in farm expansion, technology and farming practices.

 

The increase in farm costs, when combined with increased seasonal income volatility, results in tighter financial margins per hectare and increases the complexity of decision making. However, exciting opportunities exist and result in successful outcomes for progressive growers when making informed decisions supported by their trusted advisers.

 

Recently the Reserve Bank of Australia (RBA) reported that debt in the farming, forestry and fisheries sectors had more than doubled over the past 10 years to about $62 billion. They also noted that debt per business had increased from 2006 to 2011, and there were 19,000 fewer farming enterprises.

 

Trends in income and costs in a 2012 analysis of 32 Victorian Wimmera and Mallee farms, conducted by ORM, was reported in GRDCs Ground Cover Jan – Feb 2013 edition. This ORM data included 14 Victorian Mallee farms and showed that over the last 10 years their income had increased and costs had doubled while the surplus remained similar.

 

Figure 1 includes all costs and therefore may vary from taxable income or profit as calculated by accountants.

Figure 1.  Average farm income and costs for a sample of Victorian Mallee farms from 1997/98 to 2011/12.

Figure 1.  Average farm income and costs for a sample of Victorian Mallee farms from 1997/98 to 2011/12.

 

Profit drivers for broadacre farms

Annual income for Australian broadacre farms are amongst the most variable in the world. Australia’s seasons, combined with main input costs set at a global level, result in large volatility in financial performance and therefore profit.

 

When preparing action plans for 2013, individual businesses draw on a broad range of information, some global and beyond their influence and others individual and requiring advice tailored to suit their own circumstances.

 

Information available to broadacre farms in 2013 includes:

Global

  • Price trends for commodities (grain) and inputs (fertilizer, chemical  and fuel);
  • Technology, machinery capacity and efficiency;
  • Finance, interest rates and availability of funds; and
  • Farming system, crop varieties, GM technology etc.

 

Individual

  • Family goals and needs;
  • Risk profile, attitude and capacity of decision makers;
  • Machinery and labour, allocation and effectiveness; and
  • Cash flow and balance sheet, profit and equity growth.

 

Good decisions usually occur when emotions are low and knowledge is high. Many farmers would say ‘gut feel’ is their best decision support. However ‘gut feel’ is often the result of their own analysis of knowledge gained through talking to their peers and advisers, then tailoring advice, and their own experience and knowledge, to their individual circumstances.

 

Advisors to grain growers

Modern farm businesses are more complex as a result of increased farm scale, intensification of crop production systems, regular introduction of new technology and the need for employed labour. They generally have a larger asset base when considering business succession and family needs. Grower decision making can be supported by a wide range of advisers as summarised in Figure 2.

Figure 2. A range of advisers to Australian grain growers.

Figure 2. A range of advisers to Australian grain growers.

Each advisory sector provides expertise in their area of knowledge. The business manager or owner has the challenge of combining the advice to develop an action plan most appropriate for that individual farm business.

 

Advice to individuals

Business life cycle

Equity ($) growth over time provides a guide to the life cycle stage of a business. The stages of growth have different priorities for profit allocation and performance benchmarks. The run of seasons and family support are key contributors to successful outcomes and the time it takes to move through the business life cycle.

 

Figure 3 represents the business life cycle a cycle which typically takes a generation (25 years) to complete.

Figure 3. Business life cycle.

Figure 3. Business life cycle.

 

Benchmarks for the business life cycle stages are outlined in Table 1.

Table 1. Benchmarks for the stages of the business life cycle. Key: Green indicates good; yellow indicates okay; and red indicates poor.

Table 1. Benchmarks for the stages of the business life cycle. Key: Green indicates good; yellow indicates okay; and red indicates poor.

 

Priorities

Table 2. Priority areas for the stages of the business life cycle.

Priority Area

 

Emerging

 

Growing

 

Consolidating

 

Standing still

 

Re-inventing

 

Profit Allocation

 

Profit ($)

 

Reinvest into business

 

Reinvest into business & land

 

Reinvest and some tax planning

 

Tax and retirement plans includes off-farm

 

Tax and reinvest into business and land

 

Farm Scale

 

Buy vs. lease or share farm

 

Lease or share farm

 

Buy small parcels, main growth is lease/share

 

Buy when equity permits, will lease/share

 

No increase in scale, Investing off-farm

 

Actively pursuing purchase, will lease/share

 

Machinery

 

Capital Purchases

 

2nd hand

 

Upgrade into higher capacity

 

Upgrade into new technology

 

Good machinery.

 

Good machinery, upgrade regularly

 

Labour

 

Family vs. Employees

 

Work off-farm to supplement living

 

Own Labour, some contractors

 

Family labour, and casuals

 

Family labour, often two generations

 

Family labour plus full-time employees

 

Lifestyle

 

Individuals & family

 

Enthusiastic  & keen to work

 

Balancing high work loads with family time

 

At risk of burn-out. Holidays are important

 

Good work-life balance.

 

Motivated by success, have flexible lifestyle choice

 

 

Risk profiles – Different for each individual and each business

Individuals respond differently to change.  Some individuals enjoy the challenge of change, while others prefer the comfort of familiarity.  There is no one correct response to change and the response will vary according to each particular change event. However if change is to be adopted successfully then all in the team need to be comfortable and accepting.

 

The ORM/GGA FarmRISK tool is designed to improve decision making through a better understanding of the risk profiles for the business and the people involved.

 

A RISK PROFILE is comprised of RISK CAPACITY and RISK ATTITUDE.

 

Risk capacity

Risk capacity refers to the ability of the business to incur risk.  Capacity can be rated as low, medium or high and is measured by the following:

  1. Equity i.e. debt to asset ratio.
  2. Financial reserves i.e. liquid assets, on or off-farm.
  3. Income variability i.e. seasonal variations offset by income spreading between years.
  4. Diversification of income i.e. non-farm income from contracting or wages.
  5. Cost structures i.e. costs matched to income.
  6. Overhead or fixed costs i.e. level of drawings relative to income.
  7. Management skills i.e. experience, positive attitude, track record.
  8. Insurance cover i.e. life and property.

 

Risk attitude

Risk attitude is a measure of an individual response to uncertainty. Individual attitudes range from ‘wary’ or risk averse to ‘daring’ or risk seeker.  There is no such thing as 'good' or 'bad' risk attitude.

Influences on risk attitude include:

  1. Level of relevant skills;
  2. Knowledge and information;
  3. Perception of probability or frequency;
  4. Perception of impact magnitude; and
  5. Degree of perceived control or choice in the situation.

Working with risk

  • Farmers with a ‘daring’ attitude and a ‘low’ risk capacity may tend to over extend their business.
  • Farmers with a ‘wary’ attitude and a ‘high’ risk capacity could be missing out on opportunities.
  • ‘Daring’ people encourage others in the team to:

        -    step out of their comfort zone;

        -    go with the gut-feel and previous experience;

        -    look for the opportunities not the threats;

        -    accept that a degree of risk taking is required; and

        -    back their own judgment.

  • ‘Wary’ people encourage others in the team to:

        -    consider the potential pitfalls;

        -    avoid unnecessary risks;

        -    not to rush in i.e. take more time;

        -    seek more information; and

        -    involve others and make the underlying assumptions explicit where ever possible.

 

Figure 4. Risk Profile.

Figure 4. Risk Profile.

 

Managing costs and variable income

After family goals and risk profiles of the individuals, business costs are a key contributor to positive outcomes. The Victorian Wimmera and Mallee study, conducted by ORM, concluded that the Mallee sample average over the last 10 years to 2011/12 showed the following changes.

  • Total profit per hectare remained similar.
  • Total income per hectare increased by 50 %.
  • Hectares farmed (scale) increased by 28 %.
  • Farm input costs per hectare increased by 69 %.
  • Machinery costs per hectare increased by 43 %.
  • Labour costs per hectare decreased by 11 %.
  • Finance costs per hectare increased by 93 %.

 

Intensification of cropping, gains in productivity, increased debt and a significant step-up in farm costs are hallmarks of the past decade.

 

What has evolved is a higher-cost/higher-income farming system with a corresponding increase in the magnitude of risks and rewards.

 

Timely advice tailored to individual businesses is a key to positive outcomes both for the family and financial performance.

 

Characteristics of profitable and successful farms

  1. They seek new ideas and outside advice from a range of sources.
  2. They network with other like minded farmers to explore and test ideas.
  3. They embrace technology judiciously, not at the 'bleeding edge', but test and watch.
  4. If someone can do something more cost effectively, they outsource the activity.
  5. They allocate roles and responsibilities.
  6. They benchmark their business performance.
  7. They understand risk and manage it.
  8. They know their markets and produce to specifications.
  9. They are proactive rather than reactive.
  10. Most importantly, they enjoy what they do.

Contact details

Phil O’Callaghan

ORM Pty Ltd

PO Box 189, Bendigo Vic 3552

03 5441 6176

phil@orm.com.au