Kapunda livestock technology expo 2022 – 2. Chris Scheid
[Music] Our first speaker today is Chris Scheid. Chris is the director and shareholder of ProAdvice based in Victor Harbour. Chris works with farming families, family corporates and small and medium-sized enterprises in a range of roles from management consulting, client manager and as a trainer in the farm management courses. He assists farming businesses throughout Southern Australia to discover and meet their business goals, adapt to industry change, understand the financial performance of their business and manage intergenerational succession. Chris's talk today is about the importance of business performance and the role of AgTech. Thanks Chris. Thanks very much to PIRSA for putting on the AgTech forums and the program that we've got today. We've got an exciting program.
I think when we think about the last few years and where we are in the commodity cycle, I think we're in a very fortunate position with where we are at the moment. A couple of good seasons good red meat prices, wool prices not too bad, they've picked up. There's still future demand. Plenty of future demand I reckon for red meat. So we're in a really fortunate position with where we are at the moment. But I still get a feel working with clients and working in the livestock enterprise planning project that we're fortunate to be involved with PIRSA, I still get the feeling that we're accidentally designing profit into our business.
So the profits that we've got now largely are as a result of good seasons and prices, but today I want to talk to you about how we might be able to deliberately design profits into our business because my fear is my fear is with inflation about to rise and what's happening with oil prices my fear is that perhaps commodity prices might come off a little bit. Perhaps input prices are certainly rising. And what happens if yields drop 10%, prices drop 10% and costs increase 10%. What will happen to
profit then? So I think now is a good time to be thinking about designing a deliberate profit in your business rather than accidental profit that's what I want to discuss with you today. Here's my seven little topics today. So I want to talk about first and foremost two different business models of running your farm business. A profit optimization model versus a taxation minimization model.
So... neither is good or bad. There's pros and cons for each and I'll present them.
We know about land values increasing so is it possible in future for our return on assets, our profitability to continue to rise with rising land values? I want to discuss as well if we do need to improve profitability our business? If we do need to design profit into the business? What are the three key drivers? What are the three levers that we need to know about to pull to improve profitability? I want to discuss in terms of improving profitability, do I get better and improve profit? Or do I get bigger? And I've got a little model there to help you ascertain whether getting better or getting bigger may be a future course of direction. And then of course when we've got profits, and we've got a farm, there's an 'innumerable' is that a word? There's an 'infinite' number of things we can do to invest in our business. So how do we make some decisions about where we invest in our in our business? And then I'll finish with some top 10 principles from clients that we're working with that are doing well in terms of profitability. That's my journey today with you first and foremost I think we need to define what profit is and what profit isn't? So first and foremost profit isn't more cash at the end of the financial year than the start of the financial year. So you think about how could we have got more cash? Well...
very simply, we may have just sold down more grain than what we had at the start of the year, for example, 600 tonne of grain and we ended the inventory at the year with the other 100 tonne of grain. So was increased cash as a result of selling down our inventory or was it due to our energy and activities. So profit is not more cash at the end of the financial year than the start of the financial year, but what profit is... it's our income from our activity on farm. It's plus the changes in our inventory.
Started with 600 tonne of grain finished with a hundred tonne of grain so we've used up inventory. Decrease in inventory or 3000 ewes and we finished with 3500 ewes, increase in inventory, so that adds to our gross profit. So gross profit is income plus the changes in our inventory. We then take away direct costs. So our direct costs are our commission, freight, input costs, etc. Our gross profit direct costs gives us a gross margin. We take away our overheads
so overhead, there are cash overheads such as accountancy, such as professional fees, rates, occupancy costs. And we take away non-cash overheads. So this is the difference between cash accounting and real management accounting. In cash accounting we wouldn't include these things, but in management accounting we're including non-cash overheads such as depreciation. So that the value of the
wear and tear on machinery. And we're also including owner's labour, or imputed labour. Talk about that next slide. So our income plus our trading inventory changes throughout the year, minus our direct cost, minus our overheads cash and non-cash. Equals earnings before interest and tax : EBIT. That's our profit.
And if we know the value of all our assets, the real value of all of our assets. Our real value of land, a real value of livestock and real value of machinery. Our EBIT divided by the total assets gives us our return on assets! And interestingly, that EBIT is directly comparable with the dividend from BHP or Telstra shares.
So now, if we're measuring profit in their business like that we can look at the opportunity costs of investing in our business as well as outside of a business. And then after profit we've got to pay the bank back some interest. And we might have to pay back some tax if we've made a good profit to get a net farm profit.
So that's our definition of profit. It's the cash changes income minus expenditure minus the inventory changes including the non-cash overheads. Now that's a very theoretical way of looking at profit. How do we practically do it?
How do we do it at ProAdvice? Well as I mentioned we've just finished the 24th Livestock Enterprise Planning workshop for 300 businesses across South Australia from Wudina to Mount Gambier. And each of those businesses, we looked at their profitability from their taxation financials. So that's the answer about how you can do it at home.
You can do it from your taxation financials. And the things in red that I've highlighted there are the only things you need to change in your taxation financials to turn a good set of numbers, an audited set of numbers, because I know you'd never tell 'porky pies' to the tax office, so they've got to be right! So if we change those three things there in red from your taxation finances, we can turn them from tax financials to management financials and we can actually work out what your profit is. So just quickly, what are they? We take taxable income from your taxation financials, and trading account. Have you ever seen your trading account your taxation financials? Your trading account is your births, your deaths, your rations, right opening and closing inventory value.
So sales are real, purchases are real, the dollars. The opening inventory numbers of livestock is real but the value is not. The closing inventory numbers is correct because I know you count all the legs divided by four and you give that to your accountant and that's your closing numbers.
But the value is not real because the tax office allows you to use market values or average cost or different values for you for your livestock. So in your trading account in your taxation financials. If I change the value of my sheep and my cattle to something like a real value, then my trading account gross profit is a reflection of what's really happening. I then from the taxable income change the value of livestock. Gives me my gross profit. Your direct costs are your direct costs listed in your profit loss in your taxation financials. Peel them off. Direct
costs, things that increase as the number of units increase, commission, freight, etc. Gross profit minus cross. There's your gross margin minus your overheads. Now the conversation I have is cash overheads are listed in your profit loss. Occupancy, professional fees, etc.
Non-cash overheads. So instead of tax depreciation, instead we look at management depreciation. And in the livestock enterprise planning workshops we asked participants what's the value of a machinery at the start of the year? A million dollars and we depreciated at 12.5%, which means about every eight years it's being turned over. So therefore the depreciation of a million dollars is about 125 000 so that's the depreciation that gets put in rather than the taxation depreciation.
Now imputed labor. What's imputed labor? Imputed or implied labor? I was thinking about this this morning and I think it's the ancient Phoenicians, I think the ancient phoenicians were before the Egyptians, I think why ancient history isn't that good. But the ancient Phoenicians had 10 principles of profitability, and I remember one of them was save 10% of everything you produce. So they didn't have banks in those days, but what they did do is they had grain inventories. So 10% of the grain they stored. So 10% of the grain
they produced actually stored. But the second principle to bring into here, is to pay yourself first. So the ancient Phoenicians even back pre-Egyptian times are talking about paying ourselves first.
Do you pay yourself first in your business? Or do you take out what's left partnership drawings at the end of the year or take a meeger draw? So the ancient Phoenicians back pre-Egyptian times were talking about pay themselves first what about you? So all we're doing in this is we're recognising what your value is really worth to your business. And imputed or owner's labor we talk about that. So we talk about that in terms of the first person being the manager and the doer at about a $115,000 per full-time equivalent.
And the second person, not a management, more doing, about $70,000. So a 2 full-time equivalent farm. A mom and a dad operation, so to speak is a 115,000 for mum the manager and seventy thousand dollars for dad the doer, because we know that mums do all the managing don't we. So quick summary.
Tonight I know you'd be really keen to do this you can look at your taxation financials you can look at your trading account put a real value for sheep and cattle in there project your trading account and there's your trading account gross profit. You can change the value. Think about the value of the machinery times by 12.5%. There's real depreciation, and then think about how many full-time equivalents work in my business. Owners working my business and $115,000 the first and $70,000 for the second. Now just before I move off that, what's a full-time equivalent? So the definition of a full-time equivalent is working at 40 hours a week 48 weeks of the year. So how many people
here work 40 hours a week 48 weeks of the year. No one. So invariably and this is the conversation we had in livestock enterprise planning workshops invariably, you know, Mum, the farm manager, is probably one and a half full-time equivalent 60 hours and Dad is probably another full-time equipment so we're probably looking at you know one and a half full-time equivalents, 115 plus a half plus 70 and that's our owner's labor that's what we take off. Now coming back a step why are we doing this? Why are we working this out? Well we're working this out because your taxation financials don't tell you the truth about your business. If you're running your business on the profit and loss that's printed in your taxation financials you might as well toss a coin to decide to invest or not invest in your business. Because you've got about a
50% chance that it's right or wrong. So all we're doing with this is we're turning your tax financials into management accounts, real figures and we're removing the subsidies. We're removing the subsidies of accelerated depreciation and removing the subsidies of not paying yourself what you're worth. So that the profit that you project from your management financials is a real profit due to your management skills and abilities. That's why we do it. Right, so that's definition of profit.
what we're trying to do. Profit optimisation versus taxation minimisation. Let's discuss that quickly. It's not a trick question here, but what are the outcomes if taxation minimisation is the focus of your business. What are the outcomes? What do you get? Would anyone be courageous enough to speak? What do you get if you aim to minimise tax? What do you get? I reckon you minimise tax, correct. You get that.
But if all your problems look like nails then the only tool you've got is a hammer. It's the only tool you use. So when you're aimed to minimize tax what does your accountant do? Accountants are very good, not besmirching accounts at all, there an excellent role and I'll tell you about the role for accountants in a minute, but how do accountants minimise tax? Well they use taxation rules such as instant asset write-off or accelerated depreciation, farm management deposits etc, and use pre-provisioning for interest etc, bring forward provisions, so they do tricky things with different things that they're allowed to do in the tax act to help minimise tax and the outcome of that is that you minimise tax. The outcome of minimising tax to me is I reckon that there is less or no profit. And I question whether there is choice in your business if there's not profit.
You're not paying tax but if you've got no profit where do you invest on farm? It's only through borrowings. Where do you invest off farm? Perhaps you can't. How do I live better and go on a holiday or send the kids to a good school. Your car. And how do I repay debt? You can only repay debt when you're paying tax. So while one is taxation minimisation and profit optimisation one of the impacts to me of taxation minimisation as a focus of your business is that invariably there's less or no profit.
And in my career started around 1990 and we saw a lot of that for 10 years. We'd come out of the wool crisis and there was a hell of a lot of taxation minimisation. I think another thing is borrowing ability is limited where your taxation minimisation. I see there's a couple of bankers here today and my understanding of the banking royal commission from about three years ago now is that in many cases where the bank manager sees a loss in your profit and loss in your taxation financials they have to tick the box of loss.
Where they see a profit they tick the box of profit. So if they're ticking the box of loss that's going against you. Perhaps borrowing's threatened to some degree And I think as well IAWO - instant asset write-off. I suspect there's a day of reckoning coming for us this year or certainly next year with instant asset write-off. So instant asset write-off is where the taxation department, the federal treasury, said at the start of the the global pandemic, that we need to stimulate expenditure and investment in the business, so we'll give you an accelerated 100% right off on machinery that you purchase. Now if you're on that scheme then to stay on that scheme and continue to write off 100 of depreciation every year you've got to keep investing in machinery.
Now many depreciation pools that I see are at zero. And so while there's no tax that they're paying this year because depreciation is so high, taxable profits are zero. What happens the next year when they can't continue to replace machinery and there is no depreciation on the profit loss? Taxable incomes will increase. Profits will be there Tax will need to be addressed.
Now the federal treasury, they are a smart group of people and do you think they knew that? Absolutely they knew that. They knew that they would stimulate investment in the economy headers and tractors etc. What, its 1.5yrs to get a header now? They knew that that would stimulate the economy. They knew that they would take this tax and take a hit. But they knew that there was
a windfall coming after investment instant asset write-offs were written off. So if one thing you need to do today is to speak to your accountant about what depreciation pool and scheme you're in? Because if you're in the instant asset write-off there's a day of reckoning coming so start planning for that. And I was thinking this morning too that if you haven't put in your 21 taxation financials which are due middle of May, there may be an opportunity to speak to your accountant about 'can I change the pool that I'm in', for example? And if I can change the pool I'm in perhaps it's a little bit better for me to pay a little bit of tax this year this financial year rather than paying a whole lot of tax in future financial years. So...
that's taxation minimisation. What about profit optimisation? What are the outcomes if profit optimisation is your destination? Well starting on the negative you're going to pay a bit of tax. You will pay a bit of tax and in tax planning with clients we talk about an optimal rate of tax to pay at 15 to 25 cents in the dollar. Now the outcomes to me or the outcomes that I've seen with paying that sort of level of tax rate is that there is surplus cash left over.
So I was only looking at a client's figures yesterday. They've got a two million dollar turnover. We just finished their tax I've got an annual general meeting with them in two weeks time and they're paying 26.5 cents in the dollar tax.
That's a lot. But... the previous financial year that we purchased four million dollars worth of land. We made four contributions of $25,000 into superannuation to help minimise tax for the family.
So we did a whole lot of different things and there's still cash for that business left over at the end of the financial year for them to do things. A holiday, payoff debt, etc. And they are paying off debt. So...
while focusing on profit means you'll be paying tax, invariably there's cash left over at the end of the year. And I think with cash you've now got choices and the choices you've got are: that you can invest on farm, you can invest off farm, you can repay debt or you can live a bit better. You can do the kitchen for mum, you can have a beach house, you can send the kids to the school that you wish. And that's what I'm about when I'm working with clients how to optimise profit in their business and then I bring the accountant in and I deliver the results, the except the expected result to the account and I say 'now minimize tax!'. And I'll talk to you about machinery investing in a slide or two's time.
So when I'm working with clients we optimize profit first and then we minimize tax second, so that we may get optimal tax rates about that 15 to 25 cents in the dollar. Okay, quick summary. Profit optimisation model versus taxation minimisation model. Well yes in profit optimisation I'll have to pay some more tax. There will be more cash left over I'll have a profit at the end of the financial year but it perhaps it's easier to pay back interest. I've got choices and lots of them and perhaps the bank can see me servicing debt and says would you like some more money for future investment.
Versus taxation minimisation, maybe there's no or less tax to pay. Maybe there's less or no cash available into the financial year. No profit. Perhaps it's a bit harder to repay interest. There are less or no choices for the business owner and perhaps the bank is asking can you repay the loan? And just a personal opinion. To me cutting my teeth in the advisory space in the 90's, there was a there was a whole dearth of this and I just wonder whether our kids perhaps not returning to succession, not returning to to the farm etc, are as a result of you know five or ten years of us not paying tax not having choices and our kids not seeing that. Let's not let that happen again.
Let's let our profit improve and let's let our profits let our kids see our profits see in joining our business so that they want to come back to the to the farm with us. Okay land values increasing. Is it still possible to improve profitability with land prices increasing? Just to go backwards to answer this question so down the bottom here. 1990 to 1999, there's 10 years there in that block. There's 10 years in this block and there's 10 years in this block.
There's 30 years of return on assets for different industries in South Australia. We're looking at the return on capital excluding land values appreciating in price. So it's return on assets. The green are wheat producers for the 10yrs, 90 to 91. The red are mixed livestock producers the yellow sheep producers, beef producers and finally sheep beef producers. So that number there is clearly that's zero so in that 1990 to 99 period wheat producers were doing well. 1990 I know the reserve price was put out in 1989.
We had 160 million barrels of wool and 160 million sheep and in 1991 we were shooting sheep for a dollar. The wool crisis continued through to the next decade and we probably cleared we 160 million bales of wool sort of 12 years later. What's the point I'm trying to make? Just have a look at the trends, so probably here. Probably here in this band land values maybe $250-$300 a DSE grazing. In this block here, 2000 to 2009, I know I was assisting clients buy land at $350 a DSE. And 2010 to 2019, so at the tail end of that we were looking at $800 - $10000 DSE to buy grazing land, cropping land of course similar.
So while land prices have been increasing over that time and while we're only looking at average returns for different industries in South Australia. On general you could say that average return on assets have increased while land values have increased. Now they're not at 5%, but there's a general trend of increasing there. So I'm confident with businesses that are designed well for profitability.
There's businesses that are designed to look at profit optimisation businesses that harvest good prices, good seasons keep costs low, that there will be good profits into the future. If we are to design profit deliberately into our business rather than accidentally. Let's look at some key principles about how we do that. So let's have a bit of a deep dive into profitability principles Now I know many have seen this I'll quickly go through this slide but to me it's a seminal piece of teaching in terms of where profit, the functions of profitability come from. So this is your bachelor of agriculture or this is your bachelor of economics degree in 10 minutes. So if we design a business we track the dollars along this axis and we track the number of units be it number of sheep or cows or area we crop along the bottom.
If we design our business from the start we need people, we need machinery, we've got a whole lot of overheads to run our business. We drench sheep, we sow a crop, we sell cattle. We've got direct costs and our overhead cost plus our direct cost gives us our total costs. We sell some sheep, we sell some cattle, we sell some crop, and we've got income and at that point there called break even everything above that line is profit.
So our income is greater than our costs so we're in profit and at this point here our costs are greater than our income so we're at loss. Okay, so so far you've completed the first semester of your agriculture degree. So let's get to your bachelor's degree now in economics.
So if we're here at break even what can we do to improve profitability? Okay... we could, can we do something with... can we do something with cost with direct costs? Could we increase direct costs and increase production or price? Could we put more fertiliser on and get a response? Could we do something like grain marketing? A client I work with, we spend 1$/ton a year on grain marketing and last year we made $3/ton.
$3 per ton from grain marketing minus one dollar of cost is a $2 margin. Divided by $3 of the income is a 66% gross margin ratio. Spend a dollar of direct cost to make three dollars of income.
There's your gross margin ratio. So we could increase direct costs, increase production, or get a better price right and we'd increase profit would you agree with me there? So that's yes and that's no so let's try it everyone. would you agree with me? Yes! Right thanks, thank you.
So that's one thing we could do, we could increase direct cost that would change our income where we'd increase our gross margin. Could we reduce direct costs? And improve our margins? Yes we could, we could as long as we didn't affect production or price. So the first one we're talking about is improving gross margins but the second cost there is overheads. Can we reduce overheads? What are overheads? Overheads typically are people and machinery.
It's hard to manage and deal with people, it's hard to run a business with less machinery. Hard to manage a business with less people right but it can be done Often when I come to businesses and look at succession planning and I've got three generations around the table. I'm thinking overhead ratio here so succession planning can be assistance in terms of reducing overheads. Overheads can be reduced but they're very difficult to do so. So first thing we can do is we can improve our gross margin. We could lower
our overhead costs and the third thing we could do is we could increase our turnover. So if this was 3000 ewes if this was 3000 lambs produced if we could produce more lambs. Better lamb survival, better lambing percentage, well then our turnover would be here and we would be in profit Now there are only three things you can do to improve profitability in business. Reducing overheads, improving gross margins or increasing turnover and that's the same for your business for my business for a bank's business, for the football club here. So the question is which is it for you? Do you need to increase turnover? Do you need to address overheads? Or do you need to look at the margins of your enterprises? And in the Livestock Enterprise Planning Workshops, my assessment would be of those 300 businesses, would be about 7.5/10 need to address, for those that are lacking profitability (some were very profitable) but for those lacking profitability about 7.5/10 need
to address turnover. About 2/10 need to look at their overheads. And 0.5/10 need to look at gross margins. So by far and away turnover, improving turnover, is the predominant vehicle for improving profitability.
Okay... Only three secrets of improving profitability. There's the key ratios. So turnover ratio is our gross profit as a proportion of the total assets. We want 15% of gross profit for our for every hundred dollars of assets. Of our gross profit we want to retain 35% or we want we're going to spend 35% retain 65% of our gross margin.
And we want to spend no more than 35% of our gross profit in overheads. If we have those ratios then we have an operating profit of 30%, there's our return on assets, even over total assets, there's no return on equity. Lease businesses, if our return on assets manage is greater than their return on assets if our profit on our own business plus our lease business is greater than just the profit on our own business then we're using lease funds well to grow our business. And for debt funded businesses, and if our return on equity is greater than our return on assets. If the return on our equity what we own is greater than the return on the whole business then we're using debt funded.
Debt funding to to grow our business. How do we fix overheads? We need to look at people and machinery invariably. People talk to me about succession planning. I was on the west coast a couple of weeks ago with a final Livestock Enterprise Planning Workshop and there was a business there that had three million dollars worth of machinery.
One million dollars worth of income. A 3:1 machinery to income, when 1:1 is pretty good. So there's some things to think about there for that producer in terms of perhaps contracting. Using existing labour to expand their business and utilize machinery a bit. So other things we can think about is substituting machinery ownership for contracting, succession planning, as I've said. For turnover...
Turnover is about production and price. So anything that increases production or increases price improves your turnover. So at the moment wheat prices are pretty good for this harvest coming up in December 22. They've taken a little bit of a kick so maybe there are opportunities to look at securing wheat prices for next year securing price. And for our gross margins we're looking at anything we do to increase turnover or reducing direct costs or the combination of both will assist with the gross margin ratio. And often if I see businesses have lots of enterprises and looking at diversifying, they can be businesses that have gross margin issues.
Okay a quick dive,b one slide into banking ratios and then bring it all together. So banks are looking to ask three questions. First question. can you service the debt? If you can't what sort of security? And thirdly if you can service the debt and if you've got security covered then do you want some more money? So a couple of key debt servicing ratios, finance costs so interest and lease is a percentage of your gross profit. Benchmark interest coverage, how much EBIT or sometimes it makes you even depreciation amortization as a percentage of of interest and borrowing costs so more than two times as a benchmark. Trend is the friend there.
Or a 3:1 or less than 3:1 debt to income ratio. So those three types of ratios, talk to the bank about the ability of your business to service debt. And of course if you can't service debt, then banks need to ensure that they have security to get their money back. So some banks look at 50% loan to value ratio and other banks 70%.
And the final thing, if you have got debt serviceability covered if you've got security covered well then often the banks their visit to you is would you like some more money. Because you must have a debt serviceability business you must have a profitable business. Tie it together. Let's bring profitability and financiability together and when we get it right this is what we get. If our turnover ratio is at 15%, is it benchmark levels represented by a $100 bill.
And if our direct costs are less than 35% of gross profit then our gross margins are at 65% 65 divided by 100. And if our overheads are at less than 35% of our gross profit then our EBIT $65 minus $35 is $30. And then servicing debt if they are at sort of benchmark levels of $15/100, well then our net operating profit is $15.
So that's a business design well overheads, turn over, gross margin, finance. That's a business down there that's got $15 and a $100 that it earns to pay tax first, to invest off farm, to invest on farm, to pay yourself better or to repay debt What happens when things aren't designed well? So let's represent the same $100 as saying turnovers there but if direct costs are 10% more than where they should be our gross margins are 10% less where they should be. If our overheads are 15% more than where they should be. So they're 50% of
income rather than 35% of income then we've only got $5 of EBIT per $100 of cash coming in. We've still got the same finance costs finance or lease costs and we've got a net operating profit that's negative of minus 10. So what looks like a lack of profit and perhaps unfortunately sometimes the banks get blamed in terms of where we've got too much borrowings and our interest rates too high, is actually not the problem. The problem
is in red there, it's the design of your business. The design of the business there has caused the lack of profitability so this is where we we need to look at our responsibility. We've had an introduction to whether I should minimise tax and whether I should optimise profit and just on that.
Yes. Look at optimising profit and then yes, use your account to minimize your tax. I'm not saying to pay lots of tax. I'm saying to use your account in the right order. Optimise your profit first minimise your tax second.
We've looked at land values and is there potential for land values and profits to improve with land values increasing. The three secrets of design for our business: our overheads, turn over, gross margin. And you need to know which one of those levers to pull. Do I get better or do I get bigger? So if I'm looking to improve profitability, do I get better with my own management or do I get bigger and go and lease and buy land. Here's a little framework matrix that might help you with that thinking.
Now this comes from Dennis Wignall who helped me put together a whole lot of ABS figures and Dennis is an excellent analyst and he's pulled together for me here mixed cropping and livestock farms, for 30 years 1991 to 2020. 30 years of mixed cropping in livestock farms. And what we're looking at here is we're looking at across the top here we're looking at quartiles of management so the top 25%, the top quarter of management in terms of return on assets is in that column. The next 25% in that column and the bottom 25% is in that column. And across this side here I've got scale of business. So down the bottom I've got small businesses less than $200,000 turnover.
$200 to $500,000 of turnover. And half a million to a million and a million dollars of turnover. And in the body of this is return on assets excluding land values appreciating so. It's return on assets profit. What I can see here with quartile one businesses, quartile one businesses that have more than a million dollars of turnover are averaging for the 30 years about 10.9%
return on assets. And I can see quartile two businesses that are half a million to a million dollars in turnover are averaging about 3.5% return on assets. The bottom 50% at 200 to 500 are doing -0.3%, so they're not
even breaking even. And the bottom 25% of small businesses are doing -8.0%. I can also see just to scale you in, that regardless of management, businesses that turn over more than a million dollars are averaging 4.2%.
Regardless of management. Regardless of management, business is half a million at 2.4%. Regardless of scale the top 25 producers are averaging 5.1% and the next 255, 2.4%. And the whole the whole shooting match for 30 years regardless of management and regardless of scale are averaging 1.3%
and probably inflation was more than that for that 30-year time period. So that's just to settle you in on that. So we're looking at management ability here and scale of business.
So the first thing to note is that when I improve my management when I go from quarter four to quartile three to two to one. Down the bottom here minus two to point seven to two point four to 5.1. I'm jumping up in return on assets by about 2% to 2.5%. So when my management gets better and I move to a different quartile my profits increasing that makes sense.
Second point: when I increase my scale and I go from from here to here to here to here, when I jump my scale that it's also increasing profit by 2 to 2.5%. Which one's easier to do? Get better or get bigger? That's not a good question to ask which one is less risky to do? Getting better? Improving yourself, timing, and management etc. etc Or is it less risky to get bigger by leasing and buying? Right it's probably easier to get better isn't it? So point number one. Point number two is that there's a minimum scale of business to be profitable. now it's less than 200,000 there at -0.8%, -0.4%, -0.2%, etc. None of them are profitable at any level.
So small businesses it's very hard to be profitable and even at 200-500,000, to turn over you've got to be in the top 25% to have some sort of chance of being profitable. So what do we do with those businesses, what can we talk about with those businesses that that perhaps don't have scale on their side. Well to me a business that's you know 200 to 250 or even 300 000 a turnover is is a half a business. In my experience I reckon Dennis has got 500,000 of turnovers a break even to be to look at profitability look at your 500 ones right you can be average at 50% and there's a 3.5%
return there that's possible just because you've got scale. But if you're smaller, then you've got to be top 25%. So to me with smaller businesses it's about what they do. So rather than being a six day a week business maybe it's a Monday, Tuesday, Wednesday business for their 300 000 turnover which is equivalent to a six day a week full-time business.
So Monday, Tuesday, Wednesday for $300,000 turnover and let's do something else, or think about doing something else on Thursday, Friday and Saturday. Maybe it's off farm work, there's plenty of off farm work there that that's available. So that's the conversation with smaller businesses but they can still be profitable they've just got to scale back their time and design appropriately. Next point. Producers at or above the $500,000 of turnover can aspire to be profitable can aspire to be at the 4% return on assets.
And the question is should you get better or should you get bigger? Well, if you know what the scale of your business is, and if you know your return on assets, then you can work out whether you're a quartile 1, 2, 3 or 4 manager. So you can work out where you are. So if you're over here at 3.5% perhaps you could improve yourself and get get better and aspire to be 6%. If you're over here then perhaps I've got to get better but if I'm over here then perhaps getting bigger is a direction of travel for me.
So I just include that so that if you know the scale of your business and you know your profitability it gives you an idea about whether getting better or getting bigger could be a direction of travel. But as you've picked up that the less risky thing to do is to get better and to continually get better Now we've designed our business to be profitable. We've got some profits, we're minimising tax with our accountant, let's have a quick conversation here about investment decision making. Where do we spend scarce capital? I don't have enough time to talk about where you spend scarce capital on a farm there's lots of places but to me again where there's profit you've got choice where there's not profit it's probably coming out of borrowings. So the investment decisions there are even more important. So I think there's four choices around tax planning time and setting your budget to look at in terms of investing.
So I think you can invest off farm number one. For succession for the generation one, for the non-farming children, and maybe there's beach house, maybe there's diversification of assets. So my example is the client I was looking at yesterday.
So 2 million turnover, 26 half cents in the dollar. We made four contributions of superannuation 25k each. Son 27, and son 23, have already got a superannuation balance of $200k.
Because of profitable businesses. So that's helping them that's helping them with their future living. And mum and dad of course as well they've made contributions over decades so that's helping them with their succession in retirement. The superannuation fund itself is a pot of wealth for non-farming children and there's been still surplus cash after they've contributed to superannuation after they've paid tax to contribute to a to a house in town to continue to diversify their asset base. So that's what's happened as a result of profit and that's what's happened as a deliberate result of designing profit in their business, minimising tax second.
There's the first choice. The second choice we have is to invest on farm. I'll discern it down to three areas that we can invest on farm. The first one is
investing in areas and increase production and productivity. So there's shearing sheds that we'll hear about from Emily today. There's AgTech and data that we're going to hear about from Nathan And there's equipment and sheep handlers that we're going to hear from Ben today, they're all decisions that we can do that we can do to improve labor efficiency and productivity. Very often there's one client that I'll visited a couple weeks time and they're very disciplined. They have an A and a B
list of capital. And they look at their A list and we sit down with their A list and we look at return on capital. So the $30k that we're going to put towards something, we look at the return on capital for a sheep handler versus this versus that versus that. So they make decisions based on where they're going to get their best return for their investment. So that's one way, Another way, perhaps I worked with a corporate client whereby retaining staff was really important so facilities so they invested in facilities to maintain and retain staff.
And the other area that we can look at in investing is improving labor efficiency. So if we're not quite at our 600k of turnover per full-time equivalent and our labor units say 500 or 550 000 for full-time equipment labor efficiency devices might help us get to that six hundred thousand per full-time equivalent turnover. Thirdly, I think we can choose to invest in ourself, children's education, beach house, farmhouse or the kitchen for example. So that's a third choice and a fourth choice is that we can repay debt. You can't repay debt unless you're paying tax. And to me repaying debt is about the future farm asset purchase.
If I can leverage my borrowings at 70% with my bank the 100k I repay in debt is effectively a $70k purchase of land in the future to come, so I can draw that back. And to me talking about inflation and perhaps costs rising and perhaps incomes dropping off with prices perhaps, there's an argument for a little bit of debt repayments and business resilience because it's what you do in the good years that determines how you survive the bad years. Last couple of slides. Just some Top 10% principles.
So here's some examples of clients that are in our top 10 percent and what they're doing. So first and foremost they haven't just got there by magic, they haven't woken up the next day and all of a sudden become a top 10% client. They've worked hard at over the time but they've looked at structure of their business. They've also had assistance.
So they've had assistance to get their business structure right. They've got their overheads designed so they're fully utilised, $600k of turnover per full time equivalent, if you're a two full-time equivalent business right it's 1.2 million dollars of turnover, if that's where you are you've got labour utilised at their right ratios. If you're at a million dollars and you need to get to 1.2 million dollars for two FTEs, then that's where leasing comes into the conversation or other opportunities there and where we add that extra two hundred thousand dollars from leasing for example and we're not adding overheads such as machinery we're just utilizing existing machinery, utilising existing labour now we're fully utilising our labour. labor To me specialization focuses energy and reduces overheads and keeps it simple.
My very quick and dirty business success the three key principles are: Do what you like doing, do what's suited to your country, so breeding sheep breeding country, cattle on cattle country, cropping on cropping country don't try to do something different. Do what you like doing. Do what's suited to your country and do lots of it. Specialise in it.
Specialisation means you've got to be profitable because, if you're not if you're not you're out of business. You need to have a base scale of turnover to be in the top 10%. So 600k per full-time equivalent. If you're under half a million dollar turnover in your business it's pretty hard to be profitable so think about Monday, Tuesday, Wednesday, business and what you can do Thursday, Friday, Saturday.
Improving gross margin ratio through efficient conversion of direct costs so think about - look at your rotations that you've just set up. Of course you've got fertilizer and you've got chemical costs you've got Roundup at $16/litre. So look at your direct costs and are you spending a dollar of direct cost for three dollars of income? And to me this is where agronomists can come in, so agronomists are about improving and making the most for you, but sometimes you could be spending two dollars to make three dollars and that's inefficient so ask your agronomist are you spending a dollar of direct cost to make three dollars of income because if your agronomist is that level there you've got your gross margins right. Leasing only works if it improves utilisation of overhead so that million dollar business to get to 1.2 that we're not adding machinery and we're not adding labour.
Level of borrowings is important, not too much not too little. The top 10% have good systems and management. So they've already identified risks and they've got policies in place to mitigate or to stop risk or to manage risks when it occurs. So therefore they're responsive with their management. I mentioned matching enterprises to environment and once you're in the top 10% getting bigger and replicating so my 1.2 million business design well here if if your business model is to grow again well then let's go and look at another 1.2 million land business and
grow again. Let's replicate and duplicate So therefore once you're in the top 10%, turnover drives profitability. I've mentioned that one last couple of takeaways. A unit of efficiency of labour is $600k full-time equivalent. I've mentioned
the machinery value ratio. The last thing i'll finish on is while I've focused a lot on tax and a lot on business design and a lot on the money side, in my experience as well where families are functioning well business profitability follows and where people are functioning well then profit also follows. And the corollary the opposite is also true. Thanks very much [Applause] [Music] [Captions - esmedia.com.au]