The specific KPIs and their set levels will be determined by the owners’ goals and aspirations. However, there are six financial KPIs to consider putting on the list.
1. Equity growth over time
This is the ultimate financial KPI, however it is often not discussed or calculated. A high level of wealth creation or equity growth over time comes from:
- investing in productive assets
- not paying too much for them
- operating them efficiently
- investing the resulting profits wisely
- capital gain.
Many dairy farmers significantly underestimate their wealth creation growth rate over time.
At DairyNZ Mark and Measure courses, most people estimate their equity growth at around 6-7 percent. But when they actually calculate it, typical results are 10-20 percent, often over long periods of time.
Many businesses and investors aim for a 15 percent annual compounding growth rate and to achieve this rate, equity must double every five years on average. Look at your own business to see if this has been achieved.
2. Break-even milk price
Focusing on cashflow is essential and can be done by calculating break-even milk price.
Table 1 shows the average farm owners in the 2012/13 season, with a $6.33/kg MS milk price, had 31c/kg MS surplus to pay down debt and invest to grow their businesses. Deducting this surplus gives a break-even milk price of approximately $6.00, i.e. the surplus would have been $0 if milk price was $6.00/kg MS.
The top 25 percent in 2012/13 had three times this surplus to grow their business and subsequently broke-even at a much lower payout of $5.40.
To improve the cash surplus and reduce the break-even milk price requires a focus on all aspects of the business, from increasing milksolids at as little cost as possible to reducing farm costs and controlling personal expenditure.
|Cashflow per kg milksolids sold||NZ average $||Top 25% $|
|Net milk income||6.33||6.35|
|Net dairy cash income||6.77||6.85|
|Farm working expenses||4.13||3.73|
|less interest and rent||1.39||1.39|
|less net drawings||0.65||0.48|
|*Cash surplus available for debt or investment in growth areas||0.31||0.94|
|Break-even milk price||6.02||5.41|
3. Operating profit
To look more thoroughly at the farm business’s underlying operating efficiency, some other non-cash items need to be included, such as depreciation, change in stock numbers, unpaid labour and feed inventory.
Operating profit is the best KPI to compare efficiency between farms and can be expressed on a per cow, per kg MS or per hectare basis.
Table 2 shows the top 25 percent of farmers have a $2.65 operating profit/kg MS compared to the $1.77 average – an 88c difference. To improve operating profit, some farm businesses can lift revenue with little, if any, increase in costs and others require cost control.
|$/kg MS||Average||Top 25%|
|Gross farm revenue||6.82||6.96|
|Operating profit margin||26%||38%|
|Operating return on assets||4.5%||7.8%|
4. Operating profit margin
The operating profit margin indicates the gap between operating expenses and gross farm revenue – and the higher the gap, the better. The average is 28 percent and the top quartile, 38 percent.
This KPI is a risk measure and having as wide a gap as possible helps cope with fluctuations in milk prices, milk production and input prices.
5. Operating return on assets (ROA)
Operating return on assets is calculated by taking the operating profit and dividing by the dairy assets. It measures whether the business is generating enough profit, in relation to the value of the assets invested, and is often compared to the return on money ‘in the bank’.
However, this KPI does not include capital gain or loss. The top 25 percent group in 2012/13 achieved 7.8 percent ROA, with the average at 4.5 percent. As a rule of thumb, if the ROA is lower than bank interest, be cautious about borrowing too much.
6. Debt to asset percentage
Debt to assets ratio or percentage was approximately 44 percent in 2012/13 for both the average and top 25 percent group. It is not a measure of performance but can assess an important area of risk in the business.
Farmers who operate profitably and have high return on assets are able to withstand higher debt levels and still continue to grow their business.
For farmers not currently in the top profitability group, be very cautious about increasing debt, even with high equity levels.
By Paul Bird, DairyNZ project manager
This article was originally published in Inside Dairy November 2014