- Knowing your farm’s profit drivers assists you in analysing the ability of the business to withstand adverse conditions, capture opportunities and to make informed expenditure decisions.
- To maintain or increase profits farmers must increase production, attract higher prices and/or lower costs.
- Whilst individually price may be the largest driver of profit, making numerous small changes across the business that cumulatively have a large impact on overall profit may be more achievable.
- Look beyond gross margins and analyse all costs of the business including operating expenses, allowances for capital replacement, management and finance costs.
- Knowing the financial capacity of the business is critical when considering additional debt or capital expenditure.
- Managing the business to limit losses is as important as maximising profit. Therefore understanding the flexibility and resilience of the business’s cost structure is essential.
- There are key management practices and skills that farmers can use to further enhance business profitability.
The vast majority of Western Australian grain, wool and sheep meat is exported. For producers to continue to sell into the export markets they will need to remain internationally competitive. Producers will continue to be challenged as they face rising costs, intensified competition from international producers and climate challenges. To maintain and improve profitability managers of farm businesses will need to have a deep understanding of their profit drivers and have plans and tactical strategies in place to profitably manage their businesses in a range of possible scenarios.
This report outlines the main drivers of profit – price, production, costs and management. Knowing a farm’s profit drivers assists managers to analyse the risk and resilience of their business and to make more informed expenditure decisions. With significant volatility in both prices and production, farm managers need to have strategies that smooth price volatility and allow adjustments to costs of production.
When analysing business profitability it is important to look beyond gross margins and capture all cost items particularly large fixed costs like finance and machinery allowance costs. By critically examining the full cost structure of their business managers can:
- assess the flexibility of their business in different production scenarios
- know the profit implications of pricing decisions
- evaluate expenditure on inputs
- plan more effectively for the future.
Debt can either constrain or support the profitability of a business. Knowing the financial capacity of the business to repay debt is therefore critical when considering increasing debt levels. This means understanding the volatility and reliability of pre-tax profit and how this influences debt repayment.
Profit should be the focus as it is profit that will service and repay the debt, not the value of land. The land value is simply security for the bank to liquidate in the event insufficient profit is generated. When considering debt to fund an investment farm managers should ensure the investment generates a greater return than the cost of the debt and ideally the return should be sufficient to repay the debt within 10-15 years.
High performing farm business managers share some common management practices and skills that further enhance the profitability of their businesses. Surveys of some of WA’s top performing farm business managers highlight they are focused on the business performance as well as the farm operations and have good planning, organisational and tactical skills to profitably manage seasonal volatility.
In this report we have used a case study for a mixed farm enterprise to demonstrate how changes to price, production or costs can impact profit. For most businesses, changes in price will have the largest impact on profit, followed by production then costs. However, to achieve the largest impact on profit overall the best approach is likely to be making small changes across the business. For example, if the manager in our case study could increase both prices received and production by 10% as well as reduce the cost base by 10% the farm business’s profit would double (100% increase).
Additionally in this report we outline suggested management strategies that can be used to improve price, increase production and lower costs to boost profit.