How Can Dairy Farmers Make Most Profit Returns on Capital?

ANALYSIS - In the modern world of farming there is a need to focus on profit returns on capital, land and labour to maximise the business potential.
calendar icon 14 March 2014
clock icon 4 minute read

 In the world of dairy farming in the UK, the focus of the farming community has been far too much on the cost per litre rather than maximising profit according to Edward Lott management consultant with Kite Consulting.

With the end of milk quotas in the EU at the end of this year, there is an uncertainty about how the dairy sector will develop, but it will still have to face the challenges of volatile prices.

While under the quota system, maximising returns on milk was the way to ensure farms remained solvent and earn a living, without quotas, farmers will need to take a more rational approach to the business.

The UK dairy industry is competing on a global market, influenced by global prices and other global factors.

The sector is having to compete with other areas of the livestock and agricultural sector for resources.

More and more the demand for dairy products is coming from the developing world, in particular from Asia and China, while demand in the developed world is remaining static.

To meet these different and varied demands the dairy farmer is having to take a different view of the business.

“You have to understand the cost of production and the strengths and weaknesses of the business,” said Mr Lott.

Mr Lott added that farmers need to examine different performance indicators to be able to map out a profitable path and improve performance.

Among the major business issues that the dairy farmer has to consider are the operation’s profitability per cow and profitability per hectare to ensure that productivity of the land is improved in a sustainable way.

Other indicators include the debt per cow and the cash cover for debt as a percentage of that debt.

Mr Lott said that compared to the rest of Europe, the British farmer is performing well in the amount of debt held when compared to the number of cows in the herd.

At present that debt stands at about £2,000 to £3,000 per cow, where in some parts of Europe the debt is £10,000 per cow.

“Many farmers in the UK have managed to drive out the cost of quotas,” Mr Lott said.

“But it is important to know the key figures to know exactly where you are. For many farms though the figures are all too often out of date.”

Mr Lott said the farmer also needs to look at the profit margin as a percentage of output as well as the rent and finance costs as a percentage of output.

Farmers also need to consider the equity of the business and what return they are receiving on that equity.

Mr Lott said that the farms need to use the figures to benchmark themselves against other farms so that they can share best practices and business information. In particular, he said, the farmers need to develop these skills with the next generation of farmers.

John Allen, managing partner with Kite Consulting, who have drawn up the business performance indicators for dairy farmers after examining the businesses of a number of British dairy farms said: “The dairy markets are evolving, with increasing demand from Asia and developing markets and the cessation of milk quotas opening up new opportunities for UK farmers.

“But as an industry, we need to evolve too and this applies particularly to how we measure and improve business performance at farm level.

“We want to move the UK dairy industry on in thinking about new business performance indicators ready for a new era.

“Total cost per litre will remain crucial for international competitiveness, but will be less relevant than profit and returns on capital, land and labour.

“This may impact on the relevance of cost of production of milk contracts in the world we are moving towards, where farmers will be able to access global markets and grow their businesses.”

Forecast Performance of Farms Examined by Kite Consulting Using Business Performance Indicators
BPI 2014 Top 25% Target
Total Milk Output (litres) 2,801,845 4,181,459 Increasing
Total retained profit £ 66,520 236,331  
Retained Profit per Cow £ 221 553 750+
Retained Profit per Ha £ 362 1,004 1,500+
Debt per Cow £ 2,572 1,727 2,500
Cash Produced and a % of Debt 12% 34% 30%
Profit Margin (%) 6.3% 15% 20%
Rent/Finance % of Output 4.8% 3.4% 5%
Owner Equity % 68% 78% 60%
Return on Equity % 4% 8.9% 20%

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