Transcript

3 Baron-Hay Court, South Perth Western Australia 6151Telephone: +61 (0)8 9368 3333 Fax: +61 (0)8 9474 2405Email: enquiries@dpird.wa.gov.au

Financial intelligence webinar 3: Medium term financial decisionsIn the audio is:

Doug Watson, Consultant, Australian Facilitation Company

Transcript

Doug Watson:

Welcome everyone to Webinar 3 in the Department of Primary Industries and Regional Development Financial Intelligence Webinar series. A reminder, I am Doug Watson and I will be facilitating this webinar today.

Special welcome to Perry, Perry Dolling from DPIRD, who is a subject matter expert in terms of farming and in particular sheep farming. And Perry is here to hold my hands and help me if there are any specific sort of farming agronomy type issues as my background is obviously more in the finance area. And just a reminder that that is our main finance of this our main focus of this series is on the financial and the numbers side of things and whilst we will get into some more operational type issues and key performance indicators etc., today and indeed in maybe Webinar 4 as well, we are trying to stick to the numbers and the figures. If you are interested more in other aspects of farming, then there are other programs of [audio break] [0:01:07] and indeed face to face through DPIRD.

There are some references in a slide at the end, if you want further information on any one of the particular aspects we talk about, then the first point-of-call is probably those references. They are all web based so you can click and go to the page.

Quick revision of where we have sort of come from in terms of the series so far and you may recall in Webinar 1, we were really focused on improving the quality of financial information [audio break] [0:01:41] particularly for decision making. So we looked at three main forms of financial reporting - profit and loss, a balance sheet and a cash flow and simply we really need all three of those to get a full picture of the farm. And some of those involved a few amendments and adjustments and putting in market values to get the best and most accurate figures for producing - for making better decisions.

So having got that sort of financial information, Webinar 2 moved on to let's focus on the long term sort of decisions that need to be made in farming. And it is those long term decisions that will override or oversee and be an umbrella over the top of our medium term decisions. And long term is probably three years plus, maybe five years plus, depends on the cycles happening in your farm and the rotations you have and that sort of thing. Medium term decisions we have defined as somewhere in that one to three year sort of range. So beyond a season but not sort of in the never - never in the future [audio break] [0:02:44].

Long term decisions were really around improving the equity in the farm and reducing the risk and what we do with our profit that we make each year and putting some priorities in place in terms of maybe reducing debt, maybe investing in the farm, maybe a tax strategy in terms of superannuation or FMDs as you are getting closer to retirement or some sort of succession plan and how you are going to work with that. So we sort of set the long term financial goal for most farmers is to improve your wealth in a sustainable manner. So that means looking at the risk and making decisions that impact on the long term rather than just from year-to- year. So we looked at a whole bunch of ratios around your financial health and determined how we could look at strengths and weaknesses within those ratios and some of those ratios were more aligned to the long term, medium term and short term.

So what we are looking at in this webinar is the next time horizon down and sort of saying well if we have got this long term goal of improving our wealth and we need to make profit to make that happen and then make decisions what we are going to do with that profit, then the medium term goals about how we are going to improve our profit performance on the farm. So we are talking profit here, we are not talking [audio break] [0:04:10] you recall from Webinar 1 the difference between the profit and loss and cash flow. Profit being the revenue you generate, less the cost incurred in generating that revenue.

So we are going to be focusing on profit and loss and in particular around the costs involved in profit and loss primarily so you can make better decisions in that [audio break] [0:04:32] to maximize the profits so you have got more options of what to do in terms of paying off debt, investing in the farm, those sort of things. Obviously we then move onto short term decisions within the season and a lot of these will be around cash flow and margins and those sorts of things. And our final webinar we will be talking about managing risk across all time horizons and some key things that we can do there.

So a bit of an overview and background as to the context of this particular session, so weve got three specific learning outcomes that we are aiming for and understanding that focusing on profit is probably going to be better than focusing on the margins within a season. Now the margins may lead to profit, but we want to make profit over that one to three years and maximize that profit, not just maximize your margin in one year, because in doing that in one year we may end up with less profit the next year through the decisions we make. So we want to look in this medium term and try and get the best profit result we can over that time horizon which might [audio break] [0:05:42] our margins are fairly steady as supposed to high in one year and then not so high in other years because of the decisions weve made. And the typical example may be the decisions you make around sheep and whether you retain them for wool or whether you sell them for lambs or the amount of your farm that is devoted to sheep versus cropping. And in the short term you might be able to maximize things while making a decision to move in one direction but then that may backfire in the next season when prices change when things move.

We want to come up with sustainable profit and that means looking at a medium term horizon and balancing some of these costs and revenues over that time. Lets make the best decisions in terms of enterprise mix etc. And one of the problems I guess in a mixed farm is that the decisions you make around sheep can often be over the 1, 3, 5 years whereas cropping a lot of your decisions might be to do with this season in particular. So if we have got a mixed farm then we need to make decisions in that medium term. Yes, this season is important, but we also need to balance that with what does that mean for the next few years as well.

And lastly a key thing that we will be talking about is if we are going to improve our profit in the medium term, then we need to look at our revenue, we need to look at our variable costs which drive our margins and we need to look at our fixed costs or overheads which the farm needs to pay irrespective of how much we actually produce each year in terms of tonnes of grain or kilos of wool or kilos of meat. So three key things in terms of improving your profit - make more revenue, have less variable costs and reduce your overheads and we will be looking at some tools and techniques that can help us in those areas.

So a quick revision from Webinar 1 and just to highlight some of the ratios we will be looking at which are the red ratios. You may remember this slide from Webinar 2, sorry not webinar 1, last week's webinar and it is mainly those red ratios around profitability that we will be looking at and a little bit of efficiency in terms of revenue to asset ratio. And your assets are including obviously your land and your [audio break] [0:08:13] improving your ratio and usage of land and machinery to generate more revenue, some of the decisions we will make in this medium term together with those two other red ones around profitability.

As farmers are largely price takers especially when it comes to grain, a lot of our focus is going to be on costs, because if there is not a lot we can do about the price, then how do we focus on producing more. So yield and production type decisions and how do we focus on spending less, our cost of production type decisions. And largely in the marketplace many of us cant influence the price per tonne of grain and whilst we might have some impact in the price per kilo of meat, based on when we sell things, by and large we are price takers rather than price makers as farmers. So our decisions are going to be around our yield and production, our enterprise mix and our cost of production to try and improve our profit in the short term.

Let's get into some useful just having a message pop up here in terms of some problems with my connections, so I just want to check in again if people can hear me, once again if I could get a yes, if you see my lips moving and okay, somewhat just been a temporary glitch in my end. Thanks Christine, thanks Adrian, terrific.

So my apologies, Katies video is sort of not working. So we have had odd issues with video and that's largely to do with bandwidth at usually at your end, but if the audio is working that's probably a good thing and if you got a copy of the slides, so I will keep going even though that message sort of threw me a bit there that there was a problem with technology.

So let's move on to talking about getting some financial information that can help us with these medium term decisions. So I mentioned a focus on costs, so let's start with costs and start to calculate something called [audio break] [0:10:44] of production and this has to do with the total cost of producing a unit of any given commodity. So for meat it might be per kilo, for wool it might be per kilo, for grain it might be per tonne. So if we can identify how much its costing us to produce [audio break] [0:11:04], would be we can start to calculate our profit per enterprise on our farm. And then we can use that information in terms of making decisions around enterprise mix, around decisions to do with what if we were able to reduce this price, what if we are able to get more for what we are actually selling. What if we actually put more hectares into pasture? What impact might that have on the total profit of the farm?

So we [audio break] [0:11:37] profit enterprise and this will vary depending upon your farm and the enterprises that you actually have. Now we are going to focus on production and cost of production rather than our profit and loss cost. You may remember that in profit and loss we actually made adjustments for timing differences between when we sell things and when we get the money for it. And we also made adjustments for changes in what we call our tradable assets, things like the size of our flock. In this calculation we are going to simplify things by just focusing on what we are producing not necessarily what we are selling. So we are going to work out our average cost of production and use that to help us make decisions. So the first step in actually doing that is to take out costs which are not directly related to either any specific enterprise and allocate them to those enterprises.

Now in terms of your slides, your slides will say start by allocating overhead expenses to enterprises and you can see in my slide I have actually changed that word and put it in blue and put indirect expenses rather than overheads. Now by and large they are very similar things but I just wanted to focus on what I mean by indirect, indirect means I can't directly associate this expense with any one particular enterprise. So a good example would be management labour. That is in Webinar 1 we spoke about allocating cost into your profit loss for the time and effort and energy taken to manage your farm. Now this may not be your drawings, this maybe a notional figure of what you would have to pay a farm manager to run your farm.

So we want to put that figure in there as a true reflection of the time and effort and energy put into running the farm because if things arent going that well, there is a temptation that you may not take that much out in drawings. And really what you are doing is reinvesting in the farm that is instead of taking 100 out maybe you took 50 out and you forgo the other 50 to help the farm along. Reinvesting in the farm basically by not taking out your full amount of drawings. If we want to get accurate figures to actually make decisions on, we want to allocate a full value to your time and efforts.

So we are going to put in an amount there that may be equivalent to what you may need to pay someone to run the farm and it's just an estimate, it's not meant to be a specific and accurate figure, it's just showing us an allocation there. And in this case, we have said 50% of it [audio break] [0:14:26] sheep and the other 50% by definition must be with crops. So that then means we move from a 100 grand per annum, 50% sheep that means $50,000 is allocated to our sheep and $50,000 to crops. And because that 100 grand is spread between the two, what we are doing in this table is finding a way to allocate them between the two different enterprises. Now the method we are using is actually your understanding of the farm and in this case it would be how much time and effort goes into sheep, how much of your time and effort goes into cropping.

We are not going to use any scientific method, this is about your intuition, your gut feel, your knowledge of your farm and the time and effort required. Now some of the people when they do this might use a ratio, you know the percentage of revenue that comes from sheep and the percentage from crops and let's allocate it that way. But I think it's more accurate to actually build upon the knowledge you have to actually work out how much should be allocated rather than use some statistical methodology because each farm is different and who knows better as to the time and effort taken than the person actually doing the work - yourself.

So thats the basis on which this is happening. This is an estimate based on your knowledge of the farm, okay. And we are going to do that for every single [audio break] [0:15:57] So any cost that we havent already directly allocated to sheep and crops, and by and large they are your overheads. There are a couple of exceptions there. And I will explain those when I get there.

Depreciation is the next expense and we havent spoken about depreciation yet and we will talk more indeed [audio break] [0:16:16] when we look at the difference between the counting figures and your own figures. Now depreciation is the allocation of the purchase price of an asset over its use for life. So if you put in fencing for your sheep and it costs you [audio break] [0:16:33] and that fencing will last you 10 years, then the depreciation would be $5,000 a year. If you buy a header for, and I am just making figures up because I dont really know, lets say $300,000 and it's going to last you 15 years, then the depreciation simply would be $20,000 a year. Its the allocation of purchase price of your assets, your plant and equipment machinery and improvements to the land like fencing, over the useful life, how long we think they will last. So in this case we have got $80,000 [audio break] [0:17:16] and the estimate from the owners of this farm is 20% of that, one fifth is relevant for sheep. And when you stop and think about it, a lot of our plant and equipment and the high cost plant and equipment is related to more the cropping side of things. So that makes sense that there is a lesser allocation in this particular instance to sheep. So we then take 20% of 80, which is 16 and then 80% of 80 which is 64 and we allocate the 64 to the crops and the 16 to the sheep. And we go through all the other costs that haven't been allocated to each enterprise or are not easily allocated to each enterprise and we allocate them out.

Now Katie actually emailed me last night with a very good question, is fuel and oil an overhead or is it a variable cost. And I said well generally its a variable cost because its going to go up and down with how much you produce, how many hectares you put into certain crops, you might require more use of tractors and more use of headers. But there is also an element of fuel and oil where you are driving into town and back and doing other things on the farm which are spread between the two different enterprises. So in this case we are going to call it an indirect cost, something that hasnt yet been allocated between sheep and crops. And in this case the bulk of our fuel and oil just as with our depreciation is at [audio break] [0:18:49], cropping 85% and 15% to sheep. So we take the 60 and 15% is 9 and the balance is [audio break] [0:18:57].

Plant repairs similar sort of spread, the estimate is 15% for sheep but here is something that is more 100% sheep, water, fencing, that sort of thing. So we are going to allocate the full price of that and cost of that to our sheep. We are going to take our insurance and allocate that based on our understanding of our insurance premium and what it actually covers and allocate 30% to sheep and 70% to crops. And lastly admin rates, accounting fees that sort of thing, the general costs of running the farm and we are going to split that 50 50. So in total our overheads or indirect costs in this case, the things that havent been spread between the different enterprises on the farm, all add up to 360 and based on these allocations [audio break] [0:19:58] and 238,000 for cropping.

Now that we have that information we are in a better position to actually build a bit of a profit and loss for each enterprise because we spread out the indirect costs and allocate them between crops and sheep.

Now I am going to take a drink of water at this point of time and get you guys to ask me any questions about that [audio break] [0:20:28] the indirect costs between the two different, in this case two different enterprises, sheep and cropping. So if you have any questions just type them in to the chat box now while I take a sip of water.

I must have explained that really well or the audios is gone and no one is hearing me at all but I am sure that is not the case.

Okay so lets move on to our next page and this is probably one of the more difficult sort of tables to sort of read and interpret but we will try to make it as simple as possible. [Audio break] [0:21:19] doing here is calculating the profit and loss on enterprise production. Remember this is production not sales. So however much wool we produced, however many kilos of meat we produced, however many tonnes of grain we produced, what did it cost us is what we are working out here.

So if you look at the top here, I have called it direct cost, probably in your slides it is called variable costs, these are the costs we can directly associate with each enterprise. So shearing for example with our sheep or drenching is a 100% sheep and we can allocate this straight away and with our cropping maybe it is around the chemicals we are using or if we get a contract harvester in, thats directly associated with cropping and in this case we have $200,000 the direct cost for our sheep and 325 for our cropping.

The line above that is saying that how many hectares of arable farm land is used for each enterprise so we are not including the non-arable. That is just a bonus if your sheep can graze on that because there is nothing else you could do with that sort of thing. So its a cost that is there no matter what so we are only looking at your arable land here, the things that have alternative purposes and uses. So in this case we have got the 200 and the 325 and then based on our previous table we have allocated the overheads or in this case, I have coloured them in blue, indirect cost just to help you explain what, understand what I am actually referring to.

We have taken those two figures from the previous table, 122 for sheep and 238 for cropping and allocated them to the two different enterprises. Now this next line, line 3 and you can see the numbers [audio break] [0:23:20] identify each row in the table is, maybe you are going to take a little bit of understanding in that we have allocated a cost of land. Now this is a notional cost, its not an exact cost, it is not a dollar cost, it is a cost to help us work out the true cost of production. One of the major inputs into farming is obviously the land and we need to recognize that if we are to produce some management figures that accurately represent the full costs of using that land.

So we are going to use a commercial lease rate and in this case for 1,000 hectares, we have set a 150,000 grand for cropping and for sheep. It is the opportunity cost of that land, if you didnt use that 1,000 hectares, could you lease it out to someone for 150? So if you are going to actually use it yourself consider that $150,000 as a notional expense in working out the full cost of production. And if you cant cover that cost in what you are doing then maybe you are best just leasing that land out to someone else?

So its a good thing to put in to allow us to understand the full cost of production and make good decisions about the use of our land. So we need to put a cost in to reflect that just importantly understand it is not a obviously dollar cost, its just a cost we are putting in there to fully reflect the true cost of what we are doing such that we can make better decisions on our enterprise mix and whether we lease out land or lease more land and what if we changed our costs, what would that actually result in?

Add up all the costs for our sheep, we just 472,000 and all that cost of cropping and we get 713. We then divide those total costs by the number of hectares, so 472 divided by the 1,000 and 713 divided by the 1,000 and we get a cost of production per hectare. $472 per hectare for sheep, 713 and there is the formula at the side there, you can see the formula for the total cost of production, 1+2+3 and then we take 4 divide it by the number of hectares or arable hectares. Now lets start to work out the cost of production and we are going to do it on the basis of that unit production, that kilogram, that tonne of grain or kilogram of wool.

So the first line says, well, how much have we produced over this season, so in this case we are taking an average over the last three years and its actually 90,000 kilograms of lamb. So what we are actually using here is the carcase weight at weaning and carcase weight being about 45% of the live weight. It is important we align the kilograms of production to the variable costs, up here the 200,000 that helped us produce that and we want to do this every year in terms of at the same time. We dont want to wait until the sheep are bigger or at different stage or whether they are smaller otherwise this will not provide us consistent results in terms of our cost of production.

So I am going to call on Perry, if anyone has any questions about that so have a think about what that figure actually represents because it is a bit easy to understand, I guess, in terms of the tonnes of grains produced. We will talk about the kilograms of meat produced and we have drawn a line and made an assumption that we are doing this at weaning and then taking the kilograms, multiplying by 45% of the live weight to get the carcase weight. Because what we want to align it to is the price at the abattoir and the price paid per carcase rather than live weight.

So if we have produced 90,000 kilograms of lamb and 2,800 tonnes of grain then what we do is we take 4 the total cost of production, 472 for our sheep, we divide it by 90 and we get an average cost of production $5.24 and on a similar basis for our cropping we get $255 a tonne. If the price per kilogram for that carcase is $4.50 and it is costing us $5.24, then we take the $4.50 and we multiply it by 90,000 kilograms. Our total value is $405,000 of production so this isnt sales, this is what we have produced, the 90,000 multiplied by three year average price of $4.50 that means $405,000.

So you can see that, that actually means when it comes to sheep we have made a loss, when it comes to lamb, sorry, we have made a loss because the cost of production for sheep is 472 but the value of that production was 405. Whereas with our cropping with the value of production using $280 a tonne with 784 but the cost of production was 713 so we have actually made 71,000 and we see that $71,000 figure down the bottom there. So this isnt looking too good in that we have made a loss there in terms of 67,000.

Just ignore that 280, that is a bit of typo that should be $71,000, so we have made a loss of 67 but we do have some wool to sell and we have got 25,000 kilograms of wool. The next line, how much would we need to get for that wool to cover that $67,000 loss we have made so far in our sheep enterprise? And if we take the $67,000 and we divide by the 25,000 which is minus 9 divided by 10, 9 divided by 10 is 68 and then we see that the actual price we are using as the last three years average is $10 a kilogram for greasy wool. So obviously we are making a profit 10 times the 25,000 kilograms is 250,000, 250,000 minus the 67 loss on lambs means the sheep enterprise has actually produced $183,000 profit using these figures. So cropping has come in at 71, whilst if we just consider the lambs we have made a loss of 67, but we need to look at [audio break] [0:30:43] and we have actually made a profit of 183 and in fact if wool was only $2.68, we would have broken even with our sheep.

So you can start to see we are starting to get some figures that help us make decisions, you know, what price do we think wool will be in the future? Is it going to be more than $2.68, how much more, $10, but you might say well next season I might think it is only $8. Well then you can start to calculate what you anticipate in terms of profit, you can start to do some What-if analysis. What if I could reduce my direct cost or indirect cost, what if I could improve my production and produce more kilos or more tons? What impact would that actually have?

So let me just check my notes here in terms of explaining that table and hopefully I have explained it reasonably well. A couple of key things, a notional cost of land, to reflect the value of the land we are actually using and you can see now cost of production we are not putting in something like interests because typically we would be borrowing money to either buy plant or buy land or invest in assets on the farm. We have covered the assets in the depreciation when we allocated that in our indirect costs, we have covered the cost of land, we have line 3, row 3.

So we dont want to actually put in interest and finance costs because they are already technically covered with these land allocation and appreciation costs we have put in to our figures. So once again I am going to stop there because that is pretty key sort of table to understand the costs of production. And the potential profit on production, we say potential, because we havent actually put sales in there we have just put a value on what we have produced and there might be timing differences or there might be differences in tradable assets your flock size, your grain holdings, those sorts of things to actually calculate your profit. So we are working out here your cost of production and profit on enterprise production. So I give people a chance to ask any questions they may have and if there is any, if there any technical, I will get Perry on stage so he can answer them. But if you are pretty comfortable with the numbers and figures and I think the comments at the side showing you where they come from should help in terms of understanding this.

This is one of the key homework activities for your farm is to try and calculate your costs of production and we give you a blank table like this in this pretty key slide to be able to go back to. Any questions? Not seeing anyone typing so looks like Perry, you might have got out of that one easily but there are some more slides down the track which may require your expert advice.

So just a quick slide here to sort of show how the cost of production and the profit on enterprise production relates back to profit and loss. We are not going to spend a lot of time on this one but I will just show you the difference between the calculations we have just done working out the profit on enterprise production. And then we are going to convert it to actually wool sales and lamb sales. So you can see some figures in here in terms of what we have actually sold rather than what we potentially have produced. We still got the same cost of production, the 472 but in this case there is an adjustment for a change in the size of the flock.

And obviously we are going to add back the land cost because that was a notional cost, that was a made up cost to reflect the true value of the land we are actually using. It is not a financial cost, we are not paying any one for that land but we are putting it in there so we get more accurate figures so we can make better decisions. So we end up with an earnings before interests and tax with the sheep at 229 and we do similar things with the crop and once again we add back the land that we allocated to crop, the land cost.

So we get 221 there, we add the 221 and the 229, we get 450 and now we take off the finance costs, okay, because we have added those land costs back, finances is cost that we need to consider, we get 250 less our tax giving us 175. So thats not the same if you remember the previous slide, we had, you know, 183 and 71, 254 and we are getting 175 here. The difference being finance costs, these land costs and the movement in our flock size. So the accounting profit and loss would be more this figure down here based on what we have actually sold rather than what we produced.

So hopefully that distinction is reasonably clear to people, the key one is we want to use this cost of production to help us make decisions, but understand how it fits in with our profit and loss. Just one more slide and I will ask for any further questions in terms of, well the other thing we havent considered here, sorry, is drawings and I know drawings was asked about in Webinar 1 in terms of where are they reflected and you may remember that in the overheads we had that 100,000 management labour and that was the entry to reflect the costs and the time and the efforts spent managing the farm.

So that is essentially our drawings and thats included in the indirect cost we allocated to sheep so thats included in our costs of production for sheep, remember it was a 50:50 allocation so there is a 50 grand in there. And there is also a 50 grand in our crop cost of production so there is a 100 grand actually in there, we could take that 100 grand out and actually put the drawings further down here but we have already allocated it, it is already in there. [audio break] [0:37:17] So one more slide and we will have bit of a break and you can stretch your legs and may be think of some other questions to ask myself and/or Perry, who is on the line.

And this is going beyond the numbers and figures in terms of these medium term decisions, these are financial considerations we need to take into account in terms of making enterprise mix type decisions. How much do we put into cropping, how much into sheep? And it is very difficult to put these into numbers, dollars and cents, but it is important to consider them as qualitative factors in making financial decisions. So qualitative as opposed to quantitative, so stuff we cant put into numbers and figures and the first one is when you look at your enterprise mix then we find that there is a benefit in terms of having a mix of sheep and cropping because it diversifies your income. You are not putting all your eggs in to one basket, you are not a 100% weight and then the weight price crashes or a 100% sheep and the wool price crashes. You are spreading the risk by diversifying your income. When we look at risk in Webinar 5, what we will see is some studies have shown a negative correlation between wool and meat, sheep meat and grain prices. What does that mean, it means over time when one is up the other is slightly down and when the other one is up the first one is slightly down.

By evening out the two you are managing some of the risks of price fluctuations, by having a diversity of income through that negative correlation between wheat and sheep. Second one to consider is the value of pasture and sheep in terms of weed control over that medium term, you know, a rotation one to three years, if we were just looking at the one year then we may not be considering the benefit of having pasture and sheep in a rotation. It also [audio break] [0:39:48] less chemicals when the weeds are controlled better and we need less fertilizer when the soil is healthier. And I guess from my limited knowledge of farming pasture crops or lupins feed crops put nitrogen back into the soil which can then lessen your fertilizer bills for future years of cropping and an improvement in yields through mixed farming.

And in fact a lot of research and benchmarking and we have highlighted some of the issues around benchmarking and the need to maybe bench mark yourself. But in terms of top farmers having at least [audio break] [0:40:29] sheep as opposed to 100% in cropping. In effect the cropping profit is artificially being propped up through that mixed farming and having sheep in your rotation and having pasture crops in your rotation. We arent able to put a figure on these sorts of things but they are true considerations in terms of thinking of your enterprise mix. So once we are going to focus on some numbers and we have given you some numbers in terms of the cost of production to start to make medium term decisions about your mix. Also think about some of these more qualitative sorts of concerns that you need to take on board around risk, around the cost of chemicals, around the cost of fertilizer, around potential benefits in terms of yield.

So why dont we take a break there, we have been going 45 minutes or so and as we take a break just 5 minutes, we will get back underway at 9.50 have a think about any questions because we have covered some pretty important financial calculations and some of them may require a bit more explanation. So if that is required by all means type those questions in and we will deal with them when we come back from the break at 9.50.

So welcome back for those that have rejoined us and good question from Katie, Most of our lambs go at stores price per head, how do I get a figure for kilograms or can I just do it as average price per head? Look , my immediate response for that and you can see that I have asked Perry whether he wants to come on board, Perry is typing and rather me give a response or I may wait for Perrys response. I am just thinking that is about consistency, it is about putting a cost per productions. So if that is how you get paid, per head, then you should be considering maybe instead of doing it per kilo, doing it per head.

So let us see what Perry actually says in his typed response. Anyone else have any other questions, now would be a good time to type them in as we move into the second half of the Webinar. Around looking at profit drivers and maybe decisions we can make around those profit drivers. Must be a long response, Perry is typing a bit, looks like he has hit enter. You can estimate the live weight and this is Perrys response for the [audio break] [0:43:14] maybe cant see the question or response, you can estimate the live weight and use 45% as the carcase weight or do it on per head basis as Doug has suggested.

Well, maybe I wasnt too wide of the mark; the key thing in terms of cost of production is we are trying to work out a cost per unit of production. And as with our grain its tonnes, with the wool it is kilograms and I guess for sheep it could be kilograms or it could be per head. Similarly I imagine then that might have issues as you then go and add the wool on to that being per kilogram and then working out the total from there. So hopefully that answers your question, Katie, if you could just give us a Y if you are happy or if you have a further point of clarification, Katie is happy so that is good.

Fantastic, so let us move on to the balance of our slides and the next slide comes from some research by an organization out in South Australia, I think it is the Grain Research Development Corporation the GRDC which some of our references use that site and this is across 300 different farms. And they sort of said, well, what drives the profit on the farm and the first one was around margin optimization, so margin being the variable cost away from your revenue and you are left with the gross margin.

So the less chemicals you can use and the higher yield you can get use, the less costs, sorry, of your chemicals and the higher yield or in terms of sheep in terms of reducing those variable costs but maximizing the revenue you get out of it is going to improve your margins. We will look at that quite closely in Webinar 4 which has to do with decisions you make in the short term in the season to optimize your margin. Second thing that research said is risk management, thats going to be a topic for our Webinar 5, managing risk, not taking too much risk and then it blows up or back fires on you.

Aligning your risk to your level and acceptance of risk and not going too far, people and management of the farm and that is really some of the other learning forums within the DPIRD cover much of that. There is a five day face-to-face program Plan, Prosper, Profit, I think it is PPP, Perry will correct me on that one, and Planning for Profit a one day session as well. The one we are going to focus on is develop a low cost business model and we are going to look at what that means in terms of your farm.

What is a low cost business model, so those were the four key drivers of profit and if we look at a low cost business model or we apply some of those things then we get a bit of formula here in terms of what drives profit in sheep. The price, times how much you produced minus those direct and indirect costs equals your profit. So if we can maximize our profit, the price we get for example: through the timing of our sales that could be one step we take, obviously maximizing production, yield, quickly we can get our sheep to grow to the right size so that we can sell them. And we will look at some KPIs that can help you monitor that in a minute and then optimizing our costs and when it comes to sheep one of main costs is obviously going to be around labour. Notice that we have actually talked about optimizing costs, we dont talk about minimizing. Minimizing suggests get them as low as possible but that may have a negative impact on your production. So we want to optimize them, we want the best level of costs for the balance it gives us in terms of what we are actually producing.

So our low cost business model is largely around the figures we have generated in our cost of production calculations. So lets take that a step further and look at the profit and loss on a farm and those cost of production type figures and say what does it mean in terms of some of the decisions that we can actually make? So we can either increase our revenue, reduce our variable or direct costs or reduce our overheads or indirect costs. Three key steps in terms of being more profitable, so we have got more money to invest in the farm to grow our wealth sustainably in the long term.

See how the medium term goals are linking into those longer term goals. So three key steps, let us look at an example and I do a bit of work in the retailing [audio break] [0:48:15] rule of thumb in retailing. That is called the 6, 1, 5 rule and what I have done is applied it to a farm. And what it says is imagine if we could increase our revenue by 6%, what if we could reduce our variable costs by [audio break] [0:48:32] of revenue and our overheads by 5%. What impact would that have on our profit. And a lot of people go, well 6%, 1%, 5%, you know it will probably have a 12% or so impact.

But let us have a look at the figures there, if our revenue or sales was a million dollars and we increase it by 6%, we have gone up to a million and sixty. If our variable costs all the cropping costs and the sheep costs that are directly associated with each enterprise, if they were 60% of our revenue then that would give us a gross profit of 400. But if we could improve them just by 1% and get them down by 59% of revenue rather than 60%. 59%, let me just show you with the pointer, 59% of a million and 60 is 435.

So it is still more than the 400 because you have produced more but it is a lot [audio break] [0:49:36] more efficient, if we get 6% more revenue, so I just had a temporary sort of outage at my end, hopefully everything is okay at your end. So we have got 435 that then means that we will end up with a, we take our overheads, sorry, and if we could reduce them by 5%, from 300 to 285, just 5% reduction somehow. Look at a way to reduce 5%, in our current situation we have got 400 less 300; we have got a net profit of 100. In this revised situation when we have applied the 6, 1, 5 rule, we have actually ended up with 150,000 in profit. We have ended up with 50% increase in profit by doing three things - focusing on improving our revenue, reducing our variable costs and reducing our overheads.

And each one of those is manageable, its not as if we are saying we want a 50% increase in revenue or a 30% reduction in variable costs or 20% less overheads [audio break] [0:50:58]. Now for your farm it might be 4, 2, 3, you know your costs better than me and what the potential is in terms of improving revenue, reducing variable costs and reducing overheads. We need to think about the risks involved in doing this, but in essence by focusing on improving our profit from a revenue and variable costs and an overhead perspective we have got a three-pronged approach to improvement.

We havent put all our eggs in one basket and that way if we achieve the revenue improvement, but not the variable costs and we achieve the overheads, we are still going to be better off. So if we only achieve two of the three, we are going to be a lot better off than focusing on one. Balanced approach and a multiple attack on improving our profit not just saying we will get more revenue. So if we would have put that into a slide, the three key things, what are you going to do to increase revenue? Maybe in your case not by six maybe it is five, maybe it is seven, you think there is more potential there.

Look at some of the benchmarks, look at your past performances and see what your potential is, and think about what capacity there is to save in overheads, look at your overheads, what potential is there? Think about the sorts of things you can do and in the coming slides we are going to identify some options for you, some may be relevant to you, some not so relevant. Its up to you to decide which is the most likely. And in Webinar 4 we are going to focus on how to reduce your variable costs by 1% so the remainder of the slides really are in those first two items there.

What are the sorts of things you can do to improve your revenue and what are the sorts of things we can do to reduce our overheads? Any questions at this stage in terms of the profit drivers and then identifying in your case it might be 7, 3, 0. I dont think I can improve my variable costs but I can improve my overheads by three and I think I can improve my revenue by seven or I know a lot of my variable costs are going up in terms of their price, so if I can keep them at 0 then I have actually made some savings because I am using less of them and I have covered that price rise.

So theyre the key focuses in terms of mathematical and financially getting a better profit and if you can do all three of those it wont be a accumulative thing, it will be an exponential improvement in your profit. So lets look at some things we could do to maybe improve revenue and we are going to focus on sheep revenue here. And Perry has provided me with some really good pointers in terms of things you need to monitor on a regular basis and, better, sorry, gone too far there. So what we are focusing on here is the availability of the information [audio break] [0:54:20] to improve your revenue.

If we are price takers largely in terms of when we go to market then it stands to reason an improvement in revenue is coming back to an improvement in production. And these are the sorts of key performance [audio break] [0:54:39] marks, figures statistics that would be relevant and appropriate in terms of monitoring to improve your production when it comes to sheep. This is more detail on each one of these is provided in your notes for this session. There is a little description and a little rationale as to why this can help you and they are split into four headings there in terms of something that is overall in terms of you should be monitoring your stocking rate, your dry sheep equivalent let winter grazed hectares and then there is four headings in terms of know the potential and what you have lost. Look at the scanning rate, the marking rate, the weaning rate and your losses. And keep track record of those and make decisions to improve those, it will improve your production. Your wool yield and quality, the average cut per ewe, per wether, the wool cut, winter grazed hectares and average microns. I guess microns is determining some of the price and premium pricing etc.

Then we look at lamb yield and efficiency, the average sale weight and I guess we have got live weight and we have got carcase weight and we have got the average age at sale and the quicker we can get them to the sale date, the better off we are going to be. And then we have got the ones in blue highlighted as minimum requirements if you like, important measures. Lambs produced per winter grazed hectare, lambs sold winter grazed hectare and the growth rate for sale date - grams per head per day. So if you can improve those you can improve your production which will improve your revenue.

And then lastly prices, average wool prices, average sale price, average sale value a head as Katies questions was sort of talking about, this is live weight and carcase weight etc. So what we are talking about here is improving your production by getting good information and then making decisions to improve any one of these to improve how much you have to sell. And if you improve your production but your overhead [audio break] [0:57:01] remain the same then on a per unit basis they are going to be less per unit. If my overheads are $100,000 and I can produce 100,000 kilos, rather 90,000 kilos, then it makes sense then on per unit basis my overheads are now less because I produce more, that is what we call economies of scale. So the higher the scale, the higher the production, the better your economies of scale [audio break] [0:57:32], the lower your unit costs for production. So some really good measures there to keep an eye on, the blue ones are the sort of must dos and the other one are maybe nice to do. So Ill be interested to reflect upon which ones you actually keep an eye on.

Now we mentioned an increase in revenue, what about what can we do to reduce the overheads? And we are going to look at a range of different options here, about 10 different options. We mentioned the wages is a key overhead especially [audio break] [0:58:11] sheep. So we are looking at permanent wages and may be setting productivity targets for those employees in terms of how much value they are adding to the farm and Can I put some measures and monitor that rather than allowing a degree of under usage of that labour if you like.

We have got to look at things like work cover and making sure we implement safe work practices [audio break] [0:58:42] to lessen the risk of a claim which might then increase our premiums down the track. So looking at OH and S and making sure we have good measures in place. We are going to talk about banking and financing in our Webinar 5 but Ill recommend this for banking as well as insurance from time to time stop and review your provider and the amount of insurance you actually have. Some insurers, the premiums drift up over the years because they call it the lazy premium because people are too lazy to check whether there is a better deal on the go and in that laziness [audio break] [0:59:22].

Repairs and maintenance: Have a good schedule and keep to that schedule. Dont skip things and run the risk of a major breakdown down the track. Monitor for waste and leaks in your utilities, consider libraries and online options in terms of subscription. [Audio break] [0:59:42], in general communication, how much we can communicate and how well we communicate to lessen our overhead costs and avoid confusion and inefficiencies that result from people misunderstanding things. Maybe you want to consider training and look at some excellent options in terms of free Webinars like this one, but interesting to hear some people not attending today are [audio break] [1:00:11] options in terms of free seminars etc.

Regular maintenance to optimize the use of fuel and oil and indeed in terms of things like accounting fees and professional fees in general, do as much as you can yourself, have your book in good orders so that it takes less time for your accountant or your farm advisor to provide that advice or support.

So a few key things that you might want to consider in the medium term about reducing your overheads to reduce your costs, excuse me, the cost of production. Now we did talk a little bit about labour there in terms of permanent wages and setting productivity targets. So I just want to zero in a bit on that labour and sort of, in my view I think there are three different types of tasks that people do. Tasks are unavoidable so if you are employing labour in the farm or, indeed if it is your own labour in terms of maximizing your time, and getting the most out of it, there are some things you just need to do and it is about optimizing the time you do that, administrative issues.

So are you using your software to its full advantage, any meetings you have, do they draw on the right people actually there, are they short sharp to the point and we have some follow-up on what was said at the meeting so that everyone was clear on the meeting. Cleaning up for the next task, it is unavoidable, but how can we do it most efficiently and maintenance falls into that category as well. What other task do people do?

I think we want to focus on the desirable tasks so we want to cut some time out of these unavoidable tasks, still get the outcome we are looking for but do it more quickly and more efficiently so that we can spend time measuring and monitoring. Some of those KPIs that we just looked at for your sheep, you may not keep those sort of figures. But you keep them but you can make better decisions when you have that sort of information. So focus on these desirable tasks and move away from the tasks that arent adding as much value.

Supervision and delegation, being able to develop the people on your farm such that they can do more and more [audio break] [1:02:34] pressure off the senior people on the farms so that they can spend their time on more important stuff. So invest time supervising and delegating and planning and attending training, try and get the most out of that. And dont put it off because, well, in this course it wont affect the yield this year, but you know what in the medium it may do and it might make a big difference. I wont bother about the planning, Ill just worry about it when it happens and then it happens and you waste a lot of time worrying and running around and trying to sort things out whereas if you had a plan in place it may have lessened the chances of something bad happening.

So invest some time in these things, focus on the desirable tasks and there is definitely some unnecessary tasks you want to eradicate get rid of, lessen the mistakes. Down time waiting for things. Double handling, excess capacity you have got people standing around maybe not doing anything or not optimizing their time and they on a go slow sort of thing. And you can use technology maybe, rather than using too much labour. So some general thoughts around labour productivity and some of the key focuses to try and get the best out of your time and effort and energy and costs that you are spending on labour.

We mentioned there on the at the bottom of the slide there, the use of technology so lets just focus in on a bit of plants, equipment and technology. And look at some technology that you could use that could help you be more productive. Now once again I dont propose to be an expert on this and there is a website reference in our reference slide at the end of the pack that gives you more information on these sorts of things.

But typically when we think technology, machinery, we might first go to our cropping but if we stopped and looked at cost of production and we saw the impact of some of this technology could have is the marginal benefits, greater than the marginal costs. Think back to Webinar 2 where we are talking about the pros and cons and the incremental revenue that it could help generate verses the incremental costs. Some of these might be quite low cost, but generate a reasonable return; some of them might be higher costs, but generate an even better return.

So stop and think about the benefits of these pieces of technology especially around your sheep and how they may help you improve your production, lessen errors, save money such that you can justify the expenditure through that. Then in our Webinar 2 [audio break] [1:05:36] we used something called a payback period, what is the cost, you know, $10,000 but it is going to save me a $20,000 a year, payback period six months. Wow! That seems like a pretty good investment. So have a consideration about technology across the farm not just in the cropping area and as I said there is a reference to consider when we get to that page.

As you are using machinery, think about some of these sorts of decisions to make sure that you are getting the best value from it and minimizing your costs. Should I be doing it or a contractor, should I buy a new equipment or second hand? Maybe I can share machinery with others, with neighbours etcetera. Maybe I could lease more land or add hire additional hand [audio break] [1:06:25] for more hours. Maybe it is about the logistics and efficiency or even growers so range of different considerations, you can think about in terms of using machinery more efficiently to improve your overhead costs.

So what we have done so far in this Webinar is we have started to look at medium term decisions and said, Look it is pretty important to align those medium term decisions to long term goals that you have actually set. If we want more profit to be able to give us more options in terms of investing in the farm, reducing debt, preparing for retirement, all the things that we spoke about in Webinar 2, then we need to make decisions over the next three years or so, that are going to optimize or maximize our profit.

We started by saying to do this we need some good information and cost of production is, information [audio break] [1:07:36] so we have got to allocate our indirect/overhead expenses, those expenses that are not directly associated specifically with an enterprise. And we have got to allocate them between enterprises such that we can come up with a cost of production for the enterprise. Remember this is about production not about sales and we have simplified it by taking out any timing issues or indeed any fluctuations in things like flock sizes that sort of [audio break] [1:08:05]

So with that information we can then work out a cost of production, we can compare that to what we think we are going to get in terms of sales and revenue from that cost of production per kilo, per tonne, per whatever and then we can work out our potential profit based on those sort of estimates. And that allows us to make decisions about our enterprise mix, it also allows us to make what if type decisions. What if we could improve this or change that? We also need to consider all those qualitative things in the enterprise mix; we need to think about the value of having sheep in our rotation.

And the impact on diversifying our risk in terms of fertilizers and chemicals and improving improvement of yield. Then we start to make what if decisions, we go what if we could improve our revenue by, in this case we said 6%, maybe in your case it is a bit different. What if we could improve our variable costs which we will talk about in our next Webinar or improve our overheads which we spoke about in this Webinar. And indeed if we could do all three of those then that would be a reasonable approach to improving our profit.

So let me just go back to the slides so that is a bit of a summary of what we have actually covered and I will just summarize that by looking at the learning outcomes again. We are going to use profit rather than margins for the decisions that span a season and a lot of those decisions that you make about sheep span seasons. So if you are making a decision about the whole of your farm, sheep and crops, you need to make decisions that are going to be the best in the next three or so years, not just this year if you want to optimize your profit to generate wealth in the long term. And that means managing your revenue, managing your margins and managing your overheads.

So I am going to take a bit of breather there because we have got to the end of our slides there, a little bit of sort of earlier than I thought, I thought we would go right through to 10:30 but it is only 10:20, so plenty of time if people have any questions. In terms of the homework activity, what we do is we take you through a template to calculate your own costs of production, having done that we then say, given all the options that we have spoken about and given your longer term goals, how much would you like in terms of an improvement in profit? What do you think is viable and feasible, how much do you think you could improve your revenue by and/or reduce your overheads by?

So set some targets for that and my targets were the 6, 1, 5, yours might be slightly different. Having set those targets what are you going to do to actually make them happen? And you might pick up on some of the options we have given you in some of the slides here. Remember we will be talking about variable [audio break] [1:11:00] Webinar 4 so primarily the homework is around revenue and overheads. Things around your labour, your machinery usage, your other general sort of overheads as well. So that is the homework activity, thanks very much guys, have a good week, have a great Easter, have a safe Easter if you are driving anywhere.

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