FIGURING OUT FIXED COSTS IS WORTH IT

14 May 1999

FIGURING OUT FIXED COSTS IS WORTH IT

Many sheep producers are

taking a hard look at the

viability of their enterprise.

But its important to

consider all costs not just

the variable ones.

Calculating fixed costs on a

sheep enterprise has never

been easy, but it is possible.

James Garner reports

DEPRESSED lamb prices and rising costs are causing some producers to question whether they should continue to keep sheep or quit.

When examining your sheep enterprise, how do you calculate fixed or overhead costs, particularly on a mixed unit?

Looking at total costs is the only way to get the true picture, says head of ADAS Farming Neil Pickard. "Its important to take time to review your system and ask whether sheep continue to pay their share of fixed costs.

"April to June is the time to assess your system and decide. Then, if sheep are losing money and you decide to pull the plug, you can plan to sell to your best advantage.

"You wont have begun the new sheep year, so they will not be part of your farm system."

Calculating full sheep costings including overheads is never easy. Many advisers have ducked the challenge because its complicated and partly because it can reveal some hard truths.

Estimating fixed costs using figures from the Scottish Agricul-tural Colleges and John Nixs Farm Management Pocketbook underestimate their true level.

Typical overhead costs on a lowland sheep unit will be £44/ewe. However, a recent MAFF-funded ADAS study of eight northern England sheep units shows costs to be £50/ewe.

The way to calculate break-even price is to work out the total costs a ewe (table 1), suggests Mr Pickard.

Typical quoted figures for overhead costs are £44/ewe, with variable costs of £36, amounting to a total for lowland sheep of £80/ewe.

"After deducting £18/ewe for SAP and wool payment, that means lambs have to reach £62/ ewe to break even."

Then calculate output in kg/ewe by taking average numbers of lambs sold a ewe and average carcass weight. It is then possible to arrive at a break-even price.

"Where ewes average 1.6 lambs/ewe, sold at 18kg deadweight that means a break-even sale price of £2.15/kg is needed. A 10% saving in costs can reduce this to £1.87/kg."

Hard decisions may be needed if the break-even price is as high as £2.40/kg, warns Mr Pickard. "Consider whether keeping sheep is best for your business or not."

These break-even calculations use typical costs which are lower than figures found in the ADAS study. It revealed average labour bills of nearly £22/ewe and rents higher than typical figures, at £13/ewe.

Sandy Ramsay, senior rural business unit adviser at SACs Bush Estate, Edinburgh, confirms that calculating fixed costs for sheep is notoriously difficult.

"The whole industry is returning to net margins. But it is difficult to apportion costs across enterprises."

Normally once youve calculated what costs apply to which enterprise you end up with a chunk left over which are even more difficult to apply, he says.

That is the correct business area to examine, advises Mr Ramsay. "It is hard to find a technically incompetent producer. So, the theory that variable costs should be fixed and fixed costs should be variable is right."

Cutting variable costs could reduce output. But looking at fixed costs, a part of the business that many producers are less good at managing, might allow some restructuring to improve returns, he says.

"Traditionally the areas to examine are men, machines and money – particularly finance, which includes rent and interest which often needs addressing," adds Mr Ramsay.

"Some businesses are under-capitalised, having had expensive rent reviews in 1995/96 when margins were higher. At that time their rent and interest as a percentage of turnover was 15%.

"Since margins have declined that figure has risen and is now nearer 19-20% of turnover." That is too high and in some cases tenants should instigate a rent review on the basis that their turnover has decreased dramatically.

Signet business consultant Ian Ross also uses SAC benchmarks to evaluate businesses (table 2).

"The minimum net profit to have a sustainable business and enough to live on is 15% of total output. Therefore for £20,000 profit your output will need to be £133,000."

To see how secure a business is calculate its equity. Divide net worth by total assets to see what percentage equity is held by the producer, suggests Mr Ramsay.

"Owner-occupiers should have 70% or more and tenants at least 50%. That measures business security and not viability, although those below these levels will probably experience difficulty paying off interest charges."

However secure your business is, making your sheep enterprise more profitable is not easy and cutting costs might not always be the best solution, says Mr Pickard.

"Trimming costs and maintaining efficient output is the secret. For example, try to buy the same quantity of energy in a ration at a cheaper price.

"In some cases it might be better to spend more money and increase output. You might spend £5 more but achieve £10 extra return so cutting your unit cost of production."

Increasing output is the traditional way of dealing with problems but be wary when this involves purchasing more land, warns Mr Ramsay.

"Contract farming or share farming agreements are a way of expanding without increasing fixed costs."

For those planning a major change to their business structure its vitally important to consider timing of reorganisation, he says.

"Be mindful of retention periods: Ensure the change doesnt jeopardise subsidy payments." &#42

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