The Role of Sheep in Farming Systems in Changing Markets
Mark Harris
Rural Management Strategies Pty Limited
Key Words:
Sheep, Mixed farming, Continuous cropping, Risk, Enterprise mix, Cash surplus, EBIT, Capital requirement
Take Home Messages
Higher sheep prices are better but current prices are still satisfactory
Mixed Farming and Continuous Cropping systems generally produce similar financial outcomes in the Lockhart district
The Continuous Cropping system produces more income than the mixed farming system but has a higher cost structure
The Mixed Farming system is less risky than the Continuous Cropping system
Input of nitrogen from productive legume based pasture reduces the financial and management stress associated with nitrogen application in cropping systems with no legume based nitrogen input.
Background
A surge in sheep prices from early 2009 to mid 2012 significantly boosted returns in mixed farming businesses in southern NSW. However, by late 2012 prices had reverted to those experienced for much of the 2000’s. Concern has been raised that the price reduction may change the role of sheep in farming systems.
The Enterprise Mix
Livestock enterprises are price sensitive so returns will vary greatly with price received, but the benefit of the enterprise in the context of the whole business needs to be understood before any change is made. Enterprise mix decisions should not be made solely on predicted commodity prices or gross margin budgets but based on a sound analysis of the whole business.
The business analysis needs to consider:
What the farmer is interested in and good at;
The resources available and how well are they suited to the enterprise mix;
What level of risk the farmer and their family is willing and able to take;
What are the things they really need to get right to be successful.
Economic Analysis
To assess the economic impact of the change in sheep price on a mixed farm, a hypothetical 1,600 hectare farm, typical of the eastern Riverina area, was created using actual business data from RMS clients. Details of the hypothetical farm are shown in Table 1, including an alternative production model of continuous crop used to compare the no-sheep production option.
Table 1. Hypothetical Farm - 1,600 ha
Three measures were selected to compare the outcomes of the various analyses, being:
Cash Surplus - the portion of income remaining after all expenses have been accounted for including working capital interest and capital costs associated with livestock and machinery;
Earnings Before Interest and Tax (EBIT) - the portion of income remaining after operating expenses have been accounted for and measures the efficiency of the system, not the funding model of the business;
Capital Requirement - the amount of capital used to generate income and EBIT, more specifically focusing on working capital as a measure of risk.
Analysis 1 – Influence of Varying Sheep Price
Lambs prices from the Wagga Wagga Sale Yards for 2008 to 2013 (Figure 1) were collected and showed that 2008 prices were representative of a low price, 2011 a high price and 2012 a medium price of recent times.
Using this relationship, actual lamb and ewe prices received by RMS clients were obtained for the relevant years. These prices were then used in an economic analysis to observe the influence of the changing livestock prices on the financial performance of the hypothetical farm. Table 2 shows details of the prices used.
Table 2. Average sheep prices received by RMS clients
Outcome of Analysis 1 Table 3 shows the outcome of changing wether weaner and ewe sale price on the business. The cash surplus and EBIT variation demonstrates the sensitivity of the sheep operation to price, however it is worth noting that even at the lower price in 2008 the business is still producing a positive result. Compared to 2008, the cash surplus in 2011 is 44% higher and 2012 is 15% higher, which indicates that higher prices are better providing they can be obtained with little or no increase in costs. As price received increases the working capital requirement reduces which indicates less risk associated with the business.
Table 3. Trading Results and Capital Requirement for Varying Sheep Prices
Analysis 2 – Farming System Comparison
Using the same hypothetical farm, a further economic analysis was undertaken using the actual sheep prices as well as grain yield and prices received by RMS clients during 2008, 2011 and 2012 to observe how the change in sheep price interacted with the changes in other operations of the business and how this would affect the overall outcome of the business. As a comparison, a separate analysis was run alongside using the same hypothetical farm but with a continuous cropping system, using data specific to the production system from the same source. Using the same data source minimises any management difference. Table 4 shows details of data used.
Table 4. Actual Sheep Price, Grain Yield and Price
Outcome of Analysis 2 Table 5 shows the average trading results of the two production systems used in the further analysis with actual prices and yields for 2008, 2011 and 2012 used for the mixed farm and continuous cropping production systems. The average cash surplus generated by the mixed farming system over the period was 11% greater than the continuous crop system. The trading income produced by the continuous cropping system was 13% higher, the operating costs were 19% higher and the EBIT was 4% lower than the mixed farming system. This indicates that both systems are capable of producing the same end result, but the continuous cropping system requires more income to cover the higher costs. This would suggest the continuous cropping system has a higher risk profile than the mixed farming system. Nitrogen use is the most significant difference in the cost structure of the two systems. Mixed farming requires less nitrogen input due to the pasture base, however pastures need to be productive and legume based for this to be achieved. Organic nitrogen stored in the soil allows the system to be somewhat self regulating with nitrogen use and reduces the financial and management stress associated with nitrogen application in continuous cropping systems with no legume based nitrogen input.
Table 5. Average Trading Results for 2008, 2011 and 2012
Table 6 shows the capital requirement of the mixed farming business system compared to the continuous crop system. Working capital is a measure of risk because the greater the amount spent to obtain income, the greater the risk of a loss, if the income is not achieved. Significantly higher working capital is required in each year for the continuous cropping system than the mixed farming system. This also indicates that the mixed farming business has a lower risk profile. The capital associated with livestock ownership can vary in relation to price, but the underlying assets still has a value which, unlike working capital, can be realised if required.
Table 6. Capital Requirement for Mixed Farming and Continuous Cropping
Conclusion
When higher livestock prices can be obtained for little or no extra cost, the cash return to the business is significant. Spending management time on obtaining better sheep prices would benefit the financial outcome of the business providing this does not come with a similar increase in costs.
While higher sheep prices are better, the current lower prices can still produce a positive outcome for the business at an EBIT level.
A mixed farming operation including sheep and a continuous cropping operation can produce a similar cash surplus and EBIT but with different levels of risk. The mixed farming operation has a lower level of risk due to less variable costs and a lower working capital requirement.
Different people have different skills and interests and are comfortable with different levels of risk at different stages in their lives. It is important that farmers understand the mechanics of the production system being operated and its risk profile, so it is appropriate for the goals they want to achieve.