Farming System - Enterprise Mix: Livestock, Pulses, Canola, Brown Manure (2012)
Robert A Patterson
Key Words
Wheat, canola, field peas, brown manure, continuous cropping, mixed farming, sheep, enterprise mix, EBIT, cost of production, financial risk, critical success factors.
Take home messages
Decisions regarding enterprise mix for 2012 should not focus primarily on predicted commodity prices for 2012, but rather on an analysis of the production system and farm business.
Farmers’ adoption of a production system is strongly influenced by personal choice and lifestyle factors, plus labour requirements and availability
A crop sequence of brown manure field peas followed by canola and two wheat crops, can be as profitable at current commodity prices as continuous cropping, or mixed farming involving cropping and Merino sheep
A crop production system involving brown manure field peas, has less production and financial risk compared to continuous cropping, due to lower input and operating costs
Background
Many farmers in southern NSW, particularly younger ones, have switched from traditional mixed farming to more intensive farming systems involving no livestock at all. While these decisions may have been rationalised or justified on the basis of dubious economics, or the notion that sheep are nasty for soil structure and incompatible with cropping, the reality is that many of these decisions have been made for reasons of personal choice or lifestyle.
However, it is acknowledged that not many farmers excel at managing both crop and livestock production systems, as compromises do exist and have to be managed on mixed farms. Therefore the adoption of a production system where only crops have to be managed, can be rationalised on the basis that a manager is likely to perform better in an area in which he or she specialises and prefers.
The benefits of crop rotations, especially crop sequences where wheat follows broadleaf crops such as grain legumes or oilseeds is widely known and acknowledged. So also are the benefits of lucerne to livestock production (especially sheep) and subsequent crops widely known and acknowledged.
However, during the relatively dry decade of the recent past, the benefits of lucerne to subsequent crop production have been challenged by many farmers, due to failures of pasture establishment under cereal crops in dry springs, plus poor crop performance following lucerne where recharge of soil moisture has not occurred prior to cropping.
Continuous cropping would appear to be free of these negative impacts of lucerne, but obviously also fails to benefit from the positive aspects of lucerne.
Due to lack of markets, there is only very limited scope for using grain legume cash crops in rotations on any significant scale, which leaves canola as the only viable cash break crop. This has resulted in crop sequences of CWCW or CWW being adopted.
However, there is serious doubt as to whether these continuous cropping sequences involving only canola and wheat, are sustainable in the medium or long term.
The use of brown manure crops, especially field peas, is being adopted to address the shortcomings of continuous cropping, particularly with regards to Nitrogen input and herbicide resistance.
2012 Enterprise Mix
The decision on which enterprise mix to adopt in 2012 and beyond, should not be made primarily on predicted commodity prices and gross margin budgets, but based on an analysis of the overall business.
An important step in business analysis and deciding which farming system or enterprise mix to adopt, is to carry out a Situation Analysis and Strategic Audit of the whole farm business.
Situation Analysis – Where are you up to?
This involves reviewing the physical and financial performance of the farm business.
Analysis of physical performance includes reviewing the following:
– Crop yields and grain quality
– Stocking rates of pastures
– Livestock reproductive performance
– Wool cuts and growth rates
The question to be answered is:
What are the major limiting factors in crop, pasture and livestock performance?
A review of financial performance includes analysis of the change in Net Worth (assets less liabilities) over time, plus calculated budget Cost of Production (COP) and Break Even Prices (BEP) for the coming season.
At 10% pa compound growth, Net Worth doubles every 7 years. If Net Worth is not growing by at least the rate of inflation, business owners’ equity in real terms is going backwards.
Budget COP should be calculated using long term average production parameters such as crop yields and wool cuts, in conjunction with realistic budgeted costs to achieve these production levels.
The breakup of the fixed and variable cost components of the Cost of Production need to be understood, as the ratio of fixed costs to variable costs is a measure of risk and resilience of the business. A lower ratio of fixed costs to variable costs, generally implies a lower downside risk of the business to poor seasons.
As output reduces, unit costs of output increase if absolute costs remain constant. Truly variable costs adjust with the level of expected output, while fixed costs by definition remain constant, irrespective of output.
Therefore managers need to focus on the unit Cost of Production (before interest), or Break Even Price (after interest), to ensure that there is sufficient margin between these figures and their expected returns.
Strategic Audit – What business are you in?
Consideration of all of the physical and financial aspects of the business is necessary to determine what business you really are in.
A key step is a SWOT analysis of the business, which involves an analysis and review of the following:
– Strengths
– Weaknesses
– Opportunities
– Threats
Another step is to determine the Critical Success Factors of the business, in the areas of productivity, finance and management.
The questions to be answered are:
What are the key Profit Drivers? What are the key financial ratios, COP etc. What can management control? What is the risk profile and appetite of the business?
Management needs to determine, what Competitive Advantage if any the business has over its competitors, and whether that is sustainable in the medium to longer term.
Unless a business can define at least some Competitive Advantage in its operation, it is unlikely to have a sound future under continuing declining Terms of Trade.
Economics
An economic analysis of three farming systems conducted in southern NSW is presented below:
Traditional mixed farm comprising 67% crop and 33% lucerne based pasture, running a self replacing Merino flock
Continuous cropping of wheat and canola only
Continuous cropping as in 2, but including brown manure field peas grown on 25% of the arable area
The economic analysis is based on a hypothetical 1,680 hectare property in the Eastern Riverina, which is 95% arable (1,600 hectares) and run by two family labour units performing most of the operations themselves. The data used is drawn from actual farm results and figures from clients of the author.
The assumptions used for each of the three production systems are presented in Table 1.
The long term (25 year) average wheat and canola yields of the clients who have adopted the brown manure system are around 3.0 t/ha for wheat and 1.35 t/ha for canola. This yield data shows that year in year out, canola yields average around 45% of wheat yields.
Farm data from properties which have adopted brown manure peas, have shown 25 – 30% yield increases for both canola and wheat crops grown in the two years following brown manure pea crops. Wheat crops grown either after PC or PW have also shown elevated grain protein levels.
The analysis conservatively assumes a 10% increase in yield above average in the first two crops following lucerne on the Mixed Farm, and a 20% increase in yield above average in the first two crops following brown manure peas. Wheat prices have been adjusted to reflect protein levels.
Table 1: Assumptions used – 1,600 ha (95% arable) farm
Table 2 shows the estimated capital required for each of the farming systems; the main difference being capital tied up in livestock plus that required for working capital. The working capital requirement of the mixed farm is lower than for the cropping only systems, as income is received during the year from sheep and wool sales. The working capital requirement of the continuous cropping system is higher than both the mixed farm and the brown manure peas system, due to the larger area of cash crop requiring higher inputs in terms of herbicides, fungicides and artificial Nitrogen.
The amount of working capital required is a measure of the degree of risk of the system, as while there is almost a guarantee that costs of continuous cropping will be higher, there is no guarantee that gross income will be higher. This results in the potential for a greater loss to occur in that year if seasonal conditions are unfavourable, leading to the potential for this additional working capital to be capitalised into long term debt.
The brown manure system is considered to be relatively robust and low risk in drier seasons, as there is less potential to spend money on crop inputs, in the desire to achieve elusive higher crop yields.
Table 2: Capital required for business
The trading results measured by EBIT (Earnings before Interest and Tax) and three key financial ratios are shown in Table 3.
EBIT is a measure of profitability after allowances for plant replacement and family labour.
It is seen that based on the assumptions used, predicted EBIT from mixed farming is slightly higher than that from the cropping only systems, which are similar. There is little difference between the financial ratios, except that while the gross income from continuous cropping is the highest, it has the lowest EBIT Margin, due to its higher costs relative to income. This lower EBIT Margin suggests a higher degree of risk associated with this system.
The Return on Assets of mixed farming appear to be slightly higher than for both of the crop only systems. These figures show the tight margins which exist in cropping and mixed farm enterprises at current commodity prices with long term average yields, and how easy it is for debt servicing to be an issue. The figures illustrate that 1,600 hectares is barely large enough to support two families each drawing $50,000 pa, if any significant debt exists. A $1,500,000 debt would result in an equity of around 78% for these farms. The annual cost of servicing $1,500,000 (Principal & Interest) if this was amortised over 15 years at 8% pa interest is $175,000 pa, which is approximately EBIT of these farms.
Table 3: Trading results and financial ratios ($pa)
Table 4 presents the trading results and EBIT on a $/hectare arable basis. The fixed costs per hectare and the ratio of fixed costs to variable costs are another measure of risk, with lower fixed costs being more resilient, as these by definition are largely non-discretionary.
The author prefers fixed costs to be no more than 40% of total operating costs (excluding interest). This ratio is distorted however in the continuous cropping system, as variable costs in absolute terms per hectare are so high, compared with mixed farming and brown manure peas.
Table 4: Trading results ($/ha arable)
The unit cost of production of each commodity or product sold from each system is shown in Table 5.
All of the costs of a production system have to be recovered from the sale of commodities or produce from that system. Costs have been allocated on the basis of contribution to income.
The unit cost of production is considered to be another measure of risk, or potential profitability of the system. A lower unit cost of production relative to expected prices received, implies a lower risk and higher potential profit.
Farmers who are commodity producers have little or no control over the prices they receive, while the weather has a major influence on productivity. However farm managers do have control over their costs. It is cost control that differentiates those managers who are consistently successful from those who are not.
The most significant difference in the data depicted in Table 5 is the cost of production of canola under the brown manure peas system. This lower cost of production is due to dilution of absolute canola costs by the higher canola yield relative to wheat yield in this system (49%).
Table 5: Unit cost of production (Before Interest & Tax)
Conclusion Actual farm data from the past three seasons 2009 to 2011, suggests that a crop production system comprising brown manure field peas, canola and wheat, can be as profitable as continuous cropping, but with less production and financial risk. The brown manure peas system is considered to be more resilient in dry years, plus more sustainable due to the reduced reliance on selective herbicides for weed control and artificial Nitrogen for crop nutrition.
For those producers who prefer not to engage in mixed farming involving livestock, it appears that a brown manure peas system can produce financial results approaching those from mixed farming.
It therefore makes sense for producers to focus their attention where their interest and skills lie, as they are likely to perform better doing that which they enjoy.
Generally, simple but technically sound systems have less risk and perform better financially, than more complex systems.