Successful commodity businesses, over the long term, have the lowest unit cost of production and have a never-ending focus on efficiency and cost reduction. If we take our eye off the low unit cost approach it will be at our expense.
Is this how you operate your commodity business? Are you focused on achieving a low unit cost of production?
There is much debate in NZ about the most efficient production system to operate – including stocking rate, level of supplement use and infrastructure. The one thing we know for sure is we grow grass well and it’s essential to maintain our spring-calving, pasture-based system to keep our cost per kilogram of milksolids (MS) down if we are to compete globally.
DairyNZ economist Matthew Newman has frequently said the single biggest factor determining operating profit per hectare is operating profit margin, and within this operating expenses per kg MS is what you can influence. Farm businesses with the lowest operating expenses per kg MS tend to have the highest operating profit per ha. This has to be a key message for the industry. NZ farm businesses need to focus on achieving low operating expenses per unit of production.
Figure 1 shows the volatility of the payout received from 2000 to 2015. Since 2007 there has been a big lift in the milk price. Dairy farmers made a fundamental change in expenditure during 2007 with farm working expenses (FWE) leaping more than $1/kg MS and we have never recovered our low-cost focus since. FWE skyrocketed with the increased availability of palm kernel, more use of maize and barley, and increased grazing costs. The unit cost of production has increased because of these combined feed costs.
When milk prices dropped dramatically in 2014, FWE didn’t drop back in line. As an industry we need to refocus on lowering our unit cost of production. This season has seen dramatic reductions in FWE, with most farmers targeting costs in the $3.50-$4/kg MS range. The most profitable farmers tend to be in the $3-$3.50/kg MS range.
Is this an opportunity for our industry to make a fundamental adjustment and focus on retaining FWE at about $3.50/kg MS in future? The focus would move to retaining low costs and increasing the profit margin as prices lift.
Figure 2 indicates 70% of farm businesses aren’t receiving enough income to meet their first two major expenditure items – FWE, and interest and rent. They are making a loss even before other expenses such as drawings or capital expenditure are met. This graph is using a forecast cash income of $4.70/kg MS which includes the income received from milk payout, dividend, livestock income and any other dairy income received in the 2015-16 season.
With these two sobering graphs it is clear that we need to take a hard look at how we operate our businesses.
What payout should we use to plan ahead for a sustainable business? The one feature of a commodity market is the ups and downs are unpredictable. We are not able to predict milk price just as we are unable to predict interest rates or exchange rates.
Our suggestion is to:
- Prepare all financial plans using a conservative medium term payout figure, eg $5.50/kg MS, and set your business up so you can make a profit at that level.
- Develop a survival budget that survives one or two years at a lower payout, eg $4.5/kg MS.
- Bank the profits at higher payouts, eg $6.50/kg MS. Consider this a bonus and use it to reduce debt and-or retain it for future growth or as a buffer in a lower milk price season.
This approach will encourage the drive to efficiency and a reduction in operating expenses per kg MS which is an essential key performance indicator for New Zealand dairy farm businesses.
For budget templates visit dairynz.co.nz/budgets. Several top performing dairy farmers achieving FWE of less than $3.50/kg MS have shared their detailed 2015-16 budgets for farmers to compare costs.
Take control
Dairy Holdings chief executive Colin Glass observes farmers who prepare their
- annual budget
- monthly cash flow budget – monitored monthly
- GST returns
- payroll and PAYE
- themselves are far more aware and in control of their business.
“By delegating this out, farmers are missing the opportunity to understand and control their business better. Completing and monitoring your own budgets and cashflows is non-negotiable. You would understand your business better if completing payroll and GST returns too.”
