Budgeting ABC: Do you know your 2020 profit?

With the 2020 season fast approaching, do you already know which are the biggest expenses of 2020 that you should definitely consider cutting down? Have you identified which crops are profitable to grow and which bring you only loss? Read forward to answer those questions.

Many farmers using eAgronom have reported increased profits even without EU subsidies. We started researching those successful farmers and found them having a clear overview of both their agronomical end-results and financial situation. While the main decisions for the next season are made by analysing the past season, the foundation for the positive bottom line is laid with a stress-tolerant Budget plan.

Today, we are releasing a standardised Budget planning module. Our goal with every solution is to reuse already existing data and to minimise data entry the farmer has to do. And here’s where the main benefits manifest for the eAgronom users – most of the Budget plan is already filled in with 2020 forecast data. After planning the cropping, fertilisation and agrochemical tasks for the 2020 harvesting season, eAgronom users get an automatic overview of the Net Profit, crop production costs (€/t), crop profitability (€/ha), and are provided with many useful financial metrics.

But what is the Budget and what are the metrics farm owners should follow to guarantee profitability?

What is the Budget?

The budget is the financial plan for a business of a specific time period. Ultimately, the person responsible for the budget is the owner of the company who may be assisted in its production by the CEO, the CFO, and various specialists (agronomist, head of repairs, etc.). In crop production, the ideal budget is based on the harvest year in that it will run from when the first crops are sown until when they are harvested. As we always do with new developments, we talked to tens of farmers to better understand how they plan their budgets in practice. We combined the real-life examples with recommendations from farming experts to come up with a fine-tuned version of the budget, that all farmers should recognise and find straightforward to use.

Talking with farmers, we found that no two farmers do a budget in the same way. Thus, we decided to set the standard and make an easy-to-use yet powerful financial planning tool that both large and small producers can use. As the simplest version that matches harvesting season while also is set for a specific period of time, we opted to keep the direct costs (seeds, fertilisers, agrochemicals) dynamically seasonal and indirect costs calendar year based. In this way, the budget is connected to the real data run through eAgronom and reflects the true profitability of the farming (harvest) year while importantly can be the basis for cash flow and associated management accounts.

In the  eAgronom budget module, the main income (sales and subsidies) and various costs (crop inputs, depreciation, interest payments) are automatically calculated. The only additional data the user has to manually enter are the indirect operating costs (e.g. annual payroll forecast) that are usually based on previous year reports. None of the budget incomes and costs should include VAT (Value Added Tax). In summary, the income and direct costs are for the harvesting season, which is from cultivation to harvest, and indirect costs divided by the calendar year.

Example of a simple Budget plan:

  • Income from sales and subsidies: 800 €/ha
  • Cost of seeds, fertilisers, and agrochemicals: 250 €/ha
  • Cost of fuel, salaries, services, administrative, etc. operating costs: 250 €/ha
  • Machine and property depreciation: 100 €/ha
  • Loan interest payments: 10€/ha
  • Net profit = 800 – 250 – 250 – 100 – 10 = 190 €/ha

When should I develop the Budget?

Although our research shows that most farmers using eAgronom develop their budget from October to January, a preliminary budget should be developed prior to sowing the first crops of the harvest season. Therefore, the ideal time to start the budget is in May or June, ready for the next harvest season. The budget can then be adjusted in November and confirmed at which point the crop plan is more certain and there is more up to date intelligence regards resource costs and crop sales values. In November the results of the previous season are known and this will help with fine-tuning the next seasons budget and most importantly calculating the cash requirements for the next season.

Wait, but why should I plan the Budget ahead at all?

Generally, businesses that have a detailed budget, management accounts and cash flow packages are more profitable. But here is what the farming experts say:

  1. The Budget plan shows you whether your planned cropping is likely to be profitable or not, and allows you to play with various cropping scenarios to see which gives the best return and importantly is sustainable in the long term.
  2. It by virtue of the associated management accounts (what actually happens on the field and in the business) gives you a strong financial control of your business.
  3. It should clearly identify the cash needs for the business and most importantly drives the cash flow.
  4. It allows you to produce a more accurate forecast for the business as it can be updated as a ‘LIVE’ budget forecast as the season progresses and more is known of costs, yield potential and sales prices.
  5. It allows you to accurately plan all the resources needed to service the business for the harvest year and is a huge aid when ordering inputs.
  6. A well-structured budget always impresses the Bank, it provides an important part of the  financial detail required when applying for a loan and generally makes the whole process of negotiating with banks run smoother, with a higher likelihood of getting your application accepted

All you should know about Budget planning

Farm owners are in the farming business normally with one big goal to earn the profit. After all, this is what doing business is about. However, with a little input, eAgronom users and farm stakeholders can now also see the important metrics that help to minimise risks and secure profits even in stress conditions.

Gross Margin

The first metric to keep your eye on is the Gross Margin.

The Gross Margin provides a simple method for comparing the performance of enterprises that have similar requirements for capital and labour. A Gross Margin refers to the total income derived from an enterprise less the variable costs incurred in the enterprise. Gross margin is calculated on a crop-by-crop basis as it is particularly useful for comparing inter crop performance and identifying which crops are really contributing to Profit.

To know Gross Margin, you need to know the Income and Direct Input costs. For eAgronom users, the data that makes up Gross Margin is already filled in during the planning of the next season (e.g. seeds, fertilisers, sprays).

Income

Today, grain producers receive income from two main sources, selling the produced grain and various EU subsidies. EU subsidies cannot be guaranteed for the future, so the aim should be to attempt to budget so that the business is profitable without this addition. In fact, multiple eAgronom users have already been profitable without EU subsidies for multiple years in a row and continue to grow their profits.

In eAgronom, the sales revenue is calculated on a crop-by-crop basis from the area planned for each crop, forecast yield and expected sales price. While the cropping is to a degree set by the rotation, the planned yield should be the average of the harvested yield on the past five years. During the research, we often saw farmers being overly optimistic with their yield expectations. Farming is a risk management business and the professional farmer always budgets on a realistic yield, and thus avoid nasty surprises at the end of the season. While the sales price is somewhat dependent on the global market prices, many farms contract with buyers up to a year ahead to fix prices for a  proportion of the expected yield. The more expected production is fixed with the buyer the more precise the budget is. Importantly, banks tend to give lower interest rates to farmers who are realistic and can show that the estimated prices are fixed by a contract.

To note, not all the crops are sold on the market but can be used as seeds in the next harvesting season or as feed for your own livestock. Nevertheless, we recommend putting a price tag (market value) for these crops as well, as in the end, the production is an important part of your annual output whether you sell it or use it for your own use. This allows for accurately comparing crop production costs and Gross Margins.

The farming income does not include money received as loans or other financial instruments.

Direct Input costs

These include the Seeds, Fertilisers, and Agrochemicals, that will be used in the harvesting season. They are budgeted in quite some detail on a crop by crop basis with the eAgronom system. The product quantities are automatically aggregated by eAgronom from the drilling, fertilisation and spraying tasks planned for the next season. The estimated purchase prices can be taken from the pricing lists of local chemical resellers and/or agents. Again, it can be worth considering fixing the prices with the reseller with a contract, this can guard against price rises or shortages of the product later in the season and importantly brings an element of risk management into your business.

Gross Margin = Income − Direct Input costs

EBITDA = Gross Margin – Indirect Production costs

The metric that shows the cash generated by your farm is internationally called the EBITDA.

EBITDA stands for Earnings Before Interest, Taxes, Depreciation, and Amortization and is a metric used to evaluate a company’s operating performance. It can be seen as the indicator of cash flow from the entire company’s operations.

To know the EBITDA, you need to know the Gross Margin and Indirect Production costs.

Indirect Production costs

These can be viewed as the costs that are incurred to grow all the crops in the rotation for the harvest year. They include Labour, Fuel, Machinery maintenance, Property maintenance, Administration, Contracting, and Land Rental. The costs are indirect because it is not practical or of any real value to plan or allocate all these expenses by exact crop and field, and almost impossible to report accurately in such detail in management accounts. The exception to this may be diesel, which some businesses may class as a Direct cost. Thus, normally these total costs are spread over the whole farm hectares. The costs can be simply calculated by looking at the previous year results (e.g. when the total payroll was 100 thousand the last year, it will be 100 thousand plus/minus a margin depending on, say, the number of workers), or can be far more detailed by building up from a blank sheet. Building from a zero base for the first year of budgeting is always a good idea and certainly makes the budget more accurate and avoids many nasty surprises

Operating profit (EBIT) = EBITDA – DA

EBIT stands for Earnings Before Interest and Taxes (EBIT), and is a company’s net income before income tax and interest expenses have been deducted. As one of the biggest expense in farming business is the depreciation of machinery, EBIT is used to analyse the performance of a company’s core operations.

To calculate the EBIT, you need to know the Depreciation and Amortisation costs. For eAgronom users, these costs are automatically calculated from the company’s list of machinery and properties.

Depreciation and Amortisation (DA)

A large non-cash expense for the farm is the depreciation of machinery and to an extent the amortisation of properties. Tractors, harvesters, and implements (even when well-maintained) reach a point in their life when reduced reliability becomes a real risk to the business. At this point the machine is normally replaced. Most businesses depreciate their equipment over a 7-year-period. As the value of machinery is decreasing, this is counted as a non-cash cost in the financial statement, in effect, Depreciation builds up a cash fund within the business ready to fund the purchase of the new machine.

Net Profit = EBIT – Interest costs

The main metric that all businesses need to follow is the Net Profit.

Net Profit, also referred to as the bottom linenet income, or net earnings is a measure of the profitability of the business after accounting for all costs and taxes. It is the actual profit!

To calculate the PROFIT, you need to calculate the Interest costs you will pay in the next year.

Interest costs

Bank Interest on the financial obligations. There are three main types of obligations: long-term loans, short-term loans, and capital rent. The long-term obligations are usually loans for buying land or building a new building. Short-term loans are taken to fulfil periods of negative cash flow during the season (before harvest is sold). Capital rent is a loan for buying a tractor or other machine. Importantly, lease-purchases are considered as operating costs and do not reflect in the financial costs account. To note, as loans are not included in income, the principal payments are not included as a cost. The only financial costs in the budget are the interest payments, both the receiving of loans and the repayment of loans only affect cashflow, it is only the interest that affects the Profit and Loss of an Agribusiness.

(Tax)

The Tax part of the budget is highly dependent on local country tax rules. As in many EU countries there is no income tax (or corporate tax) on business profit, we decided to exclude the corporate tax from Budget to keep it simple!

Crop production costs (COP/t)

Crop production cost gives overview of spendings on tonne of production (€/t) and in the industry are referred to as COP/ T (Cost Of Production per tonne). Adding to the equation the expected selling price enables comparing different crops profitability. For example, if your COP/t is 150 € and the selling price is 160 €/t, your profit will be 10 €/t. eAgronom does these calculations for you automatically.

Here’s what you will get from eAgronom (June 2019)

Useful for getting loans from the Bank

Most farmers require a short term loan (annual) from the bank for working capital to fund operating the business during the season, additionally longer term loans (>1 year)  for buying machinery, land, or to develop new enterprises in their business may be necessary. We’ve talked to banks and asked what they need from the farmers. In addition to the past 5 year income statements and the next season’s budget, the banks are interested in multiple metrics that farmers themselves have rarely heard of. Here’s what we provide in addition to the regular budget plan.

  • Debt – The total amount of loan owed to the bank at the end of the year.
  • Debt/EBITDA – The coefficient that tells how many years it would take to pay back the Debt.
  • TDS (Total Debt Service) – Sum of the loan principals and interests paid during the budgeting year excluding principal payments of short-term loans.
  • DSCR = EBITDA/TDS – Coefficient that shows business tolerance to the loan stress.

Having a prefilled Budget accelerates the loan process at the local bank from months to weeks. Usually, farmers with a solid financial plan also get lower interest rates and seasonal offers.

Not only for grain producers

The new Budget planning module comes with complementary Excel file of all the data and metrics. This way, filling in the Budget in eAgronom is useful for any type of farm as the Excel file could be extended with any number of rows. The Excel export is made with formulas, so adding additional costs and incomes (e.g. of milk production) is easily possible. So the recommendation is to first fill in all the necessary grain production data in eAgronom, approve it with the farm owners, and then download the Excel as input for the combined whole business Budget.

Future

The budget plan is the first step in the series of features providing a better financial overview for farmer-owners and Agribusiness operators. Our next aspirations include

  • Phased comparison with reality (Year To Date comparison)
  • Cash flows – To identify the cash annual needs of the business, avoid that nasty surprise of a shortage before harvesting by identifying it and making provision to fill the gap!
  • Field-based analysis – Which fields need less inputs or should be sold?
  • Machine analysis – which machines cost the most and should be replaced soon?

In summary, eAgronom users will soon be equipped with an array of powerful financial tools to assist in steering and fine-tuning their profitable business enterprises.

Start planning your 2020 nowThe early never borrows from the late!!

Authors:
Kristjan-Julius Laak (eAgronom product owner)
Simon Boughton (Agronomical advisor)