9 November 2001

WHOLE-FARMCONTRACTS?

Opportunities for a

contractors to take on whole

farm contracts are on the

increase, reports Grant

Thorntons Gary Markham,

who explains the potential

financial advantages

available – both for the

contractor and the farmer

IT IS generally understood that the key area to reduce costs on arable farms is labour and machinery. Grant Thorntons annual survey reveals that paid labour and machinery costs on combinable crop farms is on average £122/acre, but ranges from £114/acre in the top 25% to £152/acre in the bottom group. In excess of £200/acre is usually tied up in machinery, therefore at 7%, for example, the interest charge is an additional £14/acre (see table 1).

In comparison, the costs for a whole farm contract based on a standard series of operations at commercial contracting rates will be in the region of £100-110/acre for a typical combinable rotation. The amounts actually charged, usually by neighbouring farmer contractors, are in the region of £80-100/acre. Therefore there is a potential cost saving by employing contractors in the region of £46/acre, being £136 less an average £90/acre.

It is against this background that a great deal of restructuring is happening, in the arable sector in particular.

The options usually considered by a farming business will include:

&#8226 The formation of a machinery syndicate with another neighbouring farmer

&#8226 Entering into a contract management agreement, therefore buying in labour machinery and management. These normally involve a percentage share of gross margin to the contractor

&#8226 Arranging a whole farm contract by buying in labour and machinery for a fixed price per acre

&#8226 Using contractors for certain operations based on a fixed price or charged per operation, such as: crop establishment; combining; using contractors for occasional single operations.

As always, restructuring can provide opportunities and this includes well managed contracting businesses which are able to provide a professional service to farmers and landowners. Gaining whole farm contracts or even crop establishment programmes will be of great benefit for the development of a contracting business, providing a stable and regular income stream. However, in order to ensure the work carried out is profitable the extensive use of costing sheets and capital budgets is essential.

It is inevitable that a contractor will compete against local farmers for whole farm contracts. It is therefore important to consider the differences between them.

&#42 Farmer

&#8226 A farmer will approach a whole farm contract opportunity as a means of spreading existing labour and machinery costs over a greater acreage. The calculations may be based on marginal costs, therefore the rates may be set relative to the extra costs incurred rather than an allocation of full costs. It should be noted, however, that a farming business will only be able to expand in this way up to capacity, thereafter a full costing approach will be required.

&#8226 It may be treated as a foot in the door for a more lucrative contract management agreement.

&#8226 There may be a son who is seeking to use existing farm machinery for contract work.

&#8226 A farmer will normally have some agronomic back-up.

&#42 Contractor

&#8226 Contracting is a service business and a whole farm contract will be a core business activity. The calculations for a tender will inevitably be based on a full cost basis rather than marginal costs.

&#8226 It will not normally be treated as a foot in the door because a contractor may not be in a position to offer contract management services.

Many farming businesses now use costing sheets and capital budgets, often becoming essential management tools. However, it could be argued that these are even more essential to a contracting business.

The standard use of costing sheets is to calculate the annual costs of running machinery within a farming business. A contracting business is different and a contractor needs to calculate the following:

&#8226 The price to charge for an operation to cover costs and make a profit for an existing set of machinery

&#8226 The break-even number of acres or hours required to cover costs and make a profit for an existing set of machinery at a given charge per acre.

&#8226 The price to pay for a machine to enable a profit to be made at a given acreage and charge per acre.

All of these calculations can be made on a standard costing sheet. However, it is advisable to use a computerised spreadsheet (see table 2).

Assuming the contracting charge for combining has been agreed at £29/acre, the costing sheet indicates:

&#8226 At 1100 acres combined, the contracting charge required is £30.95/acre, above the £29/acre agreed price. Therefore the profit margin will be reduced to around 12% (£3.21 on a cost of £25.79).

&#8226 The break-even number of acres required for this machine is 1350 with a cost, including profit margin, of £28.75.

Consider the agreed charge per acre is £29 and the acreage is 1000 with no known prospect of increasing it. A similar calculation using the table 2 costing sheet can be made to indicate that over a five-year period the initial capital cost must not be greater than £84,000.

In conclusion there will be increasing opportunities and it may be easier for contractors to compete as more farmers expand and reach capacity. Therefore professionally run businesses, possibly using an agronomist as required, that do their homework should be able to provide a competent and profitable service. &#42

Table 1

£/acre

Top 25% 128

Average 136

Bottom 25% 166

Table 2 – Combine

harvester costing sheet

£

Purchase price 100,000

Selling price after 32,800

five years

Depreciation per annum 13,440

Interest on average value 4,648

Insurance 996

Total annual fixed costs 19,084

Acres per annum 1,100 1,350

Fixed costs per acre 17.35 14.14

Operating cost/acre at 4 acres/hour

Labour at £9/hour 2.25 2.25

Fuel at £6.6/hour

Spares and repairs, % 5% 8%

Spares and repairs, 4.5 5.9

costs

Total cost per acre 25.79 23.96

Plus 20% profit 30.95 28.75

margin