Boost your bottom line
29 August 2019
How much income does a farm business need to generate sufficient profits? In this Q&A, Business EDGE deliverers Ian McLean and Michael Wellington outline their key findings.
Q: What’s the first step in identifying how much income is needed to increase your ‘bottom line’?
Ian: Before we determine what level of income is required to generate sufficient profits (or the bottom line), we need to know what sufficient profits are. This depends on individual circumstances and ambitions; however, there are some broad criteria that can be applied.
If the farm business is the major source of family income and consumes most of your time, we suggest that the business should generate sufficient profits to:
- cover all operating and finance expenses
- adequately compensate its owners for time spent in the business
- still have profits leftover for capital expenditure and provide for retirement, succession, and other requirements.
If all this can be achieved, it’s well on its way to becoming a sustainable business.
Q: What are the measures that can be used?
Michael: Farm income or the ‘top line’ can be measured by either gross sales (gross cash receipts) or gross profit (sales – purchases +/- inventory change). Gross profit is the more informative of the two as it reflects what’s actually produced, not just what’s sold.
The aim throughout our analysis was to determine whether gross profit could be used to predict whole-farm profit, measured as Earnings Before Interest and Tax (EBIT or operating profit), which is gross profit minus total operating expenses.
Interest and tax still need to be paid from this, so it isn’t the true bottom line, but EBIT provides the best measure of business performance, independent of financing and taxation. This concept of measures – how they’re calculated and how they relate to your business – are covered in detail in the Business EDGE workshops.
Q: What’s the minimum gross profit you need to generate a positive EBIT?
Ian: Our analysis found there’s quite a strong relationship between gross profit and EBIT, and that the EBIT of a business could be accurately predicted from its gross profit. To generate a positive EBIT (cover operating expenses and owner wages, but not cover interest or financial provisioning), a farm business in southern Australia would need a minimum gross profit of around $230,000. For northern Australia, the required gross profit is higher at $360,000.
These are effectively the break-even (before interest and tax) figures of required income for farm businesses – so the income required for the business to pay interest, tax, provisioning and generate an adequate return on capital will be more than these figures. How much more will depend on the circumstance of the individual business and the needs of the family.
Q: Why is there such a big difference in minimum gross profits for southern and northern farm businesses?
Michael: Due to higher quality pastures, southern producers generally have higher animal productivity than those in the north, enabling them to generate greater income at a given cost base. This means they don’t need to run as many animals as northern producers to achieve a set level of income.
Southern businesses also tend to have higher levels of off-farm income at a given scale than businesses in the north.
Q: What would you say to producers who are thinking about attending a Business EDGE workshop?
Ian: While it may be daunting at first, improving financial literacy allows you to understand where your business is and isn’t performing well, and helps you get quality information out of people like your accountant and bank manager. A recent attendee said that attaining financial literacy was the most valuable outcome from the workshop, because you “can’t do the rest without it”.