Five business analysis steps

Analyse your business using the following five-step process and key performance indicators.

1. Physical description

The first step before KPIs can be calculated is to ensure you have accurate physical information such as effective hectares, cow numbers and milksolids production. Many of the KPIs such as Operating profit/kgMS require accurate physical information as this allows you to effectively compare or benchmark with others.

See the DairyBase report descriptions handbook.

2. Total wealth

Reviewing your business’s current wealth position and equity growth over time indicates how successful your strategic investment decisions have been combined with operating efficiency of your business. Focus on these key total wealth KPIs.

Compounding growth in equity - over five years or greater

This equity growth KPI is the combination of:

1. operating performance of the farm business,
2. quality of the investments made, and
3. decisions made on levels of personal drawings and dividends paid out from the business.

Learn how to calculate your growth in equity over time by trying the quick trial and error method.

Review the total wealth or assets and liabilities of the business to understand business growth trends, and the level of indebtedness.

Debt to asset ratio

This KPI is the amount of money owed in relation to the business assets and is an important part of risk assessment.

Debt: Asset = liabilities ÷ assets x 100

3. Liquidity

Liquidity is the ability of the business to meet its cash commitments, e.g. farm working expenses, interest and rent, principal repayment or capital, and drawings and dividends. Find out which key liquidity KPIs to focus on. Liquidity is important because if a business is not liquid, additional borrowing will be required to keep the business afloat.

Successful businesses focus on liquidity to ensure they have high levels of cash available to continue investing in discretionary areas that align with business and personal goals.

Discretionary cash

This KPI is the cash available for future investments such as debt reduction, re-investment in the farm or investment in new ventures and drawings.

If you have been making cash losses and your debt has increased, you may think your Break Even Milk Price BEMP is too high and may be considering a change in approach. BEMP is an essential business indicator of success which highlights the ability of your business to cope with volatile milk prices.

Use the break-even milk price calculator to work out your own breakeven milk price and see where you sit against other farms. If it’s not where you want it to be, refer to the popup boxes for some ideas on what to do.

4. Profitability

Measuring core farm business profit before interest tax and capital expenditure is important as it indicates the performance of the farm's ‘engine room’ and is closely correlated to equity growth. Find out about the key profitability KPIs.

Dairy operating profit

The more profitable the farm business the more opportunity for financial progress. Dairy operating profit is the primary profitability measure used in the dairy sector.

How operating profit is derived from the cash side of the business:

• Operating profit margin percent - represents the gap between expenses and revenue and is a measure of efficiency and shows how well the business can cope with volatility of income and costs.
• Operating expenses/kgMS - is a component of operating profit but useful to look at on its own. In a commodity business, it is important that Operating expenses/kgMS do not keep rising over time or the business may become uncompetitive.

Visit Dairy operating profit

Return on Assets (RoA) and Return on Equity (RoE)

These important KPIs are for benchmarking historical performance and comparing future investments.

RoA – measures how efficiently the farm assets are being utilised. This KPI is the next step beyond just looking at operating profit alone. It takes into account both profitability and the value of the assets used to generate that profit. Return on Dairy Assets (RoDA) = dairy operating profit x 100 ÷ opening dairy assets.

RoE – measures how efficiently the owner's equity is being utilised. This KPI looks at the operating profit less interest costs as a percentage of the equity invested and is closely related to equity growth/wealth creation over time. RoE = total operating profit - interest x 100 ÷ opening equity.

See how to calculate RoA and RoE below:

The general principle is to operate your business with a return on assets above the interest rate (cost of borrowing). If this can be achieved, reliably, it is then profitable to borrow additional funds as you will be making a margin on every dollar you borrow -  commonly called leveraging.  There can be benefits to borrowing but also risks.

5. Physical performance

It is important to review the physical performance of the farm including pasture and feed management, herd fertility, animal health, nutrient levels and application rates alongside your financial performance.

Reviewing physical performance will enable you to identify your current farm system's strengths and weaknesses and identify focus areas for improvement.

To benchmark your physical performance use DairyBase and complete the level 2 physical data input forms.