 |
PROFITABILITY: Separate your two businesses
Dairyfarmers are in two businesses, which must always be kept separate - the property business and the farm business.
This is the view of Nicola Shadbolt, senior lecturer Institute of Food, Nutrition & Human Health, Massey University.
She told farmers attending the recent NZ Large Herds Conference at Napier that historically in New Zealand the property business always outstripped the farm business as a wealth accumulator.
@@While farmers are often criticised for accepting low returns from their farming business and relying heavily on those from property,@@ Ms Shadbolt said, @@they are operating a business in which few assets appreciate.
@@The opportunity cost of their capital is a combination of the returns from both the farming and the property businesses, with many expecting at least an inflation-proof investment.@@ Too frequently rural professionals use the terms profit and cash surplus (liquidity) interchangeably.
Though the overall profitability of a farm investment is the sum of its farming and property business, the farming business primarily delivers a cash result, while the property business doesn't. The problem inherent in a land investment is usually that of liquidity, not profitability.
Overall profitability is the sum of the returns from the farming business, operating profit after tax, and capital gains or losses from the property business.
Using a capital budgeting framework to take account of the time value of money, Ms Shadbolt said if the cost of capital of owning a farm is, say, 8%, an owner operator with average return on assets of 6.6% would not meet funding costs. @@This would quickly lead to a liquidity crisis unless alternative arrangements are made.@@ The common short-term response to this situation is not rewarding the family for the market value of their labour and management.
Another possible arrangement is termed passive equity, where all or part of the equity receives no cash return.
The first indicator of a liquidity crisis would be an erosion in working capital, with the mix of assets determining the ability a business has to respond to such crises, those with liquid assets being in the stronger position.
Debt also could be raised to address the crisis, but the scope to do this over time would fall as the ratio of debt to equity increased.
Ms Shadbolt calculated that an increase of just under 4% p.a. over 15 years on asset values from the property business would be needed to provide the required return. @@In this instance equity holders would need patience and would need to be reconciled to this investment being a growth (equity generation) rather than an income (cash generation) investment.
@@This has been well understood by successful farming families over the years. Longterm investment, often spanning 2-3 generations, must be able to tolerate short-term variation in returns.@@
Entry barrier
Though many successful farming families practise methods to ensure long-term farm viability such as low levels of debt, cash reserves, passive equity funds, and not rewarding family labour with cash, Ms Shadbolt said these methods create an entry barrier to farming for those unwilling or unable to practise them.
Property returns could be volatile.
For instance, in 1996-97 and 1997-98 they fell.
Ms Shadbolt said the emphasis placed on operating profit both by farmers and consultants is not misplaced because as profits increase liquidity is enhanced and risk reduced.
@@Farm investments then become income as well as growth investments,@@ she said.
If the assets of the property business and farming business are owned by different parties, the challenge is to determine fair returns for each player.
@@Unfortunately, there are a number of sharemilking agreements that have been altered in the landowners' favour because of an undue emphasis being placed on return on assets. The risks the sharemilker carries cannot be underestimated. The stick used to beat down sharemilkers will come home to roost.@@ As the measures of success used by the property business and the farm business differ, she said, to ensure fairness it might be more relevant to aim to meet the expectations of each party without attempting to achieve equivalence in returns.
|
| Issue & article archives |
|
Get the latest issue |
|
View past online digital issues.
Gain access to our archived articles
|
5 Great reasons to subscribe
- Save $33 off the cover price
- Only $6 per issue
- Delivered every month to your mail box
- The perfect gift that lasts all year
- You’ll never miss an issue
|
|
| Dairy Diary |
Dairy Diary gives an update of what is happening in
the New Zealand dairy industry over the next few months... More Information »
Dairy Diary is brought to you by Waikato Milking Systems |
|
Advertise with us!
NZ Dairy Exporter is New Zealand’s leading dairy industry
magazine, informing dairy farmers, sharemilkers, farm managers
and others within the wider dairy industry... More
Info » |
|
|
|
|
PRINTABLE
VERSION
TOP
