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01 September 2017

How to Plan for Profitable Farm Expansion

Posted By: AIB Business
aib-agri-adviser-tadhg-buckley245

Tadhg Buckley, Agri Adviser, outlines the key considerations to take into account prior to expanding your farm.

When planning on-farm investment it is unwise to base any investment decision on the performance of the farm in a very good year or indeed a very bad year. We advise farmers to take a multi-annual view of their farms and examine the performance over the previous 3-5 years, accounting for variances in profitability.

The key driver of expansion is to increase the profitability of the farm. So it’s worth asking prior to embarking on expansion, ‘What is the proposed expansion worth to the business?’ In order to achieve profitable farm expansion, there are a number of key conditions that need to be met. While in this article we will look closely at the dairy sector these considerations are applicable to other farm sectors. Here are some things to consider before expansion. 

Low Variable Cost Base

The competitive position of your existing business prior to expansion is vital in achieving profitable expansion. For a dairy business, the level of variable costs is the key. Expansion should allow a farmer to reduce his/her unit fixed cost as the fixed cost base is spread over a larger production base. However, variable costs are likely to increase in line with production – therefore, they need to be at a competitive level prior to commencing expansion.

Stocking Rate on Milk Production Platform 

In order to expand efficiently, in particular for Spring-milk systems, grazed grass will need to continue to form the vast bulk of the dairy cow’s diet. Therefore, the milk production platform available will have a major influence on how much a dairy farmer can expand on a profitable basis. For any business, there is a level beyond which it is unprofitable to further expand i.e. the law of diminishing returns. When assessing a dairy farmer’s business, this principle is most appropriately tested by examining the stocking rate on the milking platform.

Age Profile and Potential Successor

It is likely to take 10 years or more to see the full benefits of substantial expansion. In addition, the initial expansion phase is likely to involve a heavier workload for the farmer. When considering expansion, the farmer in question must take a long-term view of the enterprise examining:

  • The long-term plan for the operation
  • If a likely successor has been identified
  • If there will be significant off-farm financial demands on the business in the intervening period (such as family education costs)

Financial Benefits of Expansion

In the case of increasing cow numbers, the cost of expansion can range from €2,000/cow to €6,000/cow depending on the level of investment required. If we take, for example, a 6% fixed interest rate with a 10-year repayment schedule the annual cost of expansion/cow is as follows:

  • Cost/cow  - €2,000  Repayment/cow/year - €274
  • Cost/cow  - €4,000  Repayment/cow/year -  €548
  • Cost/cow  - €6,000  Repayment/cow/year - €822

It should be noted that the additional net margin/cow would likely be higher on the additional cows under expansion than the farmer’s current net margin/cow as fixed costs will not increase in line with expansion.

Obviously, every case will be different as the cost of capital expenditure will vary. However, the key message remains the same – based on the above calculations only the top 1/3 of dairy farmers could justify expansion with a significant per cow cost.

As Irish agriculture is now more exposed to the influence of world markets, volatility is a phenomenon that we are likely to experience more of in the future. Managing volatility will be a key component in any future farm expansion plans. As such, proper financial planning will be required prior to expansion, with expansion plans stress tested for periods of depressed commodity prices.

Are You Planning to Expand Your Farm?

We’re backing farmers with a programme of initiatives specifically designed to help you grow and develop your businesses in a planned and sustainable manner. Visit our Agri Business Site to find out how we can help you today.

 

Please be aware that all of the views expressed in this Blog are purely the personal views of the authors and commentators (including those working for AIB as members of the AIB website team or in any other capacity) and are based on their personal experiences and knowledge at the time of writing.

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