# Profitability Calculator

This tool lets you benchmark the profitability of your farm against similar farms in the industry.

## This tool lets you benchmark the profitability of your farm against similar farms in the industry.

There are three profitability measures within this tool. In order of their completeness, these are:

1. Earnings before interest, tax, and rent (EBITR) per hectare
2. Earnings before interest and tax (EBIT) per hectare
3. Profit (before tax) per hectare

#### Profit per hectare

Profit per hectare is a simple concept to understand, and is the easiest measure to derive. However, the ranking of farms on this measure is heavily influenced by the capital structure of each farm. Take two farms which are identical in all respects except that one has no debt while the other spends 15 per cent of its gross revenue on debt servicing. The farm with no debt will report a higher profit than the farm with the moderate debt loading - even though the earning rate of each farm was identical. The difference in reported profit was solely due to each farm's capital structure.

#### EBIT per hectare

To more accurately benchmark farms with differing capital structures, we use the EBIT (Earnings before interest and tax) per hectare measure. This includes the interest paid in the "earnings" of the farm, and would rate the two farms referred to above equally. So this measure gives a better view of the underlying earnings of farms.

#### EBITR per hectare

However, the industry doesn't solely consist of farms where the land is owned by the farm business. Many farms lease some or all of their land area from a third-party.

For example, consider a third farm that is functionally identical to the above two farms - except that it is wholly leased from a third-party. This farm's profit will be less than the freehold farm, while its relativity to the indebted farm will depend on the relative amounts of rental paid versus interest paid. On an EBIT per hectare basis, our third farm will lag well behind the other two - because its interest bill will be minimal and therefore gets little adjustment on an EBIT basis.

To fully compare all three farms, we need to use the EBITR (Earnings before Interest, Tax, and Rent) measure. This will "add back" the rent paid in the case of the third farm to take it to a similar basis to the other two farms.

#### Which is best?

Overall, EBITR is a better measure of the "earning power" of farms than EBIT; and in turn, EBIT is a better measure than profit. However, all three measures are closely related, and for some farms, all three measures will be identical.

These measures are not perfect - but they serve as a good starting point in analysing your farm performance. There are two particular areas where you could adjust your figures to get a "better" comparison figure:

• If your farm is run by an employed manager rather than by an owner-operator, then the salary paid to the manager would normally be part of the "profit" in an owner-operator situation. Therefore, these "wages of management" could be added back.
• Sometimes, profit (and therefore EBIT and EBITR) may be depressed in a given year through unusually high maintenance expenditure. This typically occurs when maintenance has been deferred in earlier years owing to a lack of revenue to fund it. Therefore, in those years when there is a catchup on deferred maintenance, some portion of that maintenance could be added back as "abnormal". (The corollary of this is that in years of depressed maintenance expenditure, profit should be reduced to reflect the maintenance liability for future years).

Look at the "Definitions" tab for more information on the individual inputs into these profitability comparisons.

## All comparison data in this tool are taken from the Beef + Lamb New Zealand Economic Service Sheep and Beef Farm Survey. All data are final for the years displayed.

#### Data retention

Data entered into this calculator is not collected or retained by any organisation. It is used solely for the purpose of calculating your profitability coefficients, and displaying those coefficients in graphical form for your information.

#### Data sources

You should be able to get all necessary financial data for this calculator from your farm accounts. You should be able to get your farm area from your rates demands.

#### Year

The data is for a "financial year" or "season". Around 75 per cent of Sheep and Beef Farms use a June ending financial year; a further 15 per cent end their financial year in March; and the remainder have a variety of balance dates. Because these financial years span two calendar years, the season is expressed with reference to both calendar years - for example: 2012-13.

Use the "year" that best matches your accounts. For example, if your accounts are for the year ending May 2013, then use the "2012-13" year.

#### Profit

In general, profit is your gross revenue (from farming operations) less the expenditure involved in those operations. Your accounts should show a profit figure and how this is derived. Unfortunately, account presentation varies tremendously so we need to look carefully at what is included in the profit figure.

The revenue side of profit should include:

• revenue from all "farming" activities
• cash rebates from farming activities (e.g. fuel, fertiliser)
• the value change attributed to changes in livestock numbers

and exclude:

• revenue from "non-farming" activities (e.g. horticulture)
• wages and salaries earned off-farm
• large "one-off" revenue items such as timber sales

Expenditure should include depreciation and exclude the purchase of capital items and expenditure on "non-farm" activities.

Optionally, you could adjust your farm profit (to bring it to a steady state owner-operator situation) to account for:

• wages of management where the farm is not run on an owner-operator basis (add those wages back to profit to bring to an owner-operator equivalent)
• abnormally high expenditure when there is a catch-up on deferred maintenance (add the "excess" maintenance expenditure back to farm profit to bring it to a "normal" state)
• abnormally low expenditure when maintenance is deferred to a future period (reduce the farm profit by the amount that maintenance expenditure is less than "normal").

Note that the comparison distributions have not been adjusted for these optional factors.

Profit is a required entry.

#### Hectares

Note the entry screen separates out "owned" hectares from "rented" hectares. This is simply to ensure that we capture all relevant data.

We really want "effective" hectares in each box. Effective area excludes:

• unusable area such as swamps, lakes, rivers, and reserves
• ungrazed areas such as forest blocks
• areas used for "non-farming" activities (such as horticulture).

It should include "agro-forest" areas (wide-spaced trees that are regularly grazed).

You must have hectares entered into the tool before you can do a calculation. However, the entry may be in either "owned" or "rented" hecatares (or both). Note that if you have a rented area, then you must have a corresponding rental figure (and vice-versa).

#### Interest

This is interest paid by the farm business. This includes both term and current account interest, but should exclude interest paid for "non-farming" activities.

This is not a required entry. However, for clarity, you should enter zero if you do not pay interest.

#### Rent

This is the rent paid for any rented land. This should exclude any rent paid for "non-farming" assets.

This is not a required entry per se, but IS required if you have specified a rented area.

#### Farm Class

The default comparison is against all Sheep and Beef Farms. However, you can restrict the comparison to "similar" farms by selecting the appropriate farm class and region using the filters below the chart.

Farm classes are defined in the 'Definitions' tab of the 'Lambing Calculator'. Click here to go to these definitions.

#### Notes

At a minimum, you must enter a profit figure (which could be zero, or could be negative), and an area figure. If the area is for rented land, then you must also include a rental figure.

If you don't pay interest, and you don't rent any farm areas, then all three "profitability" measures will be identical. Similarly, if you don't rent land, then your EBITR figure will be identical to your EBIT figure.

However, the overall distributions include farms with varying degrees of indebtedness and proportions of rented land. Therefore, each of the three measures produces a different distribution at the industry level.