Measuring improved profitability of Australian dairy farms

Increasing the profitability of dairy farms is a key objective of the recently published Australian Dairy Plan.

The plan sets an industry target for farm profitability, based on a national analysis of farm business performance data monitored by Dairy Australia. It is based on the profitability measures earnings before interest and tax (EBIT) per kilograms of milk solids (kg MS) and return on total assets (RoTA). These two measures are closely correlated.

The target is for more than 50% of Australian dairy farms to achieve profit of at least $1.50 EBIT/kg MS and at least 5% RoTA over a 5-year average. An average of only 22% of monitored farms reached the EBIT profit target over the past 5 years (five years up to and including 2018/19).

However, results starting to come through in our Dairy Farm Monitor Project data show that the number of farms with profits above these targets increased dramatically in 2019/20 due to improved climactic conditions in many dairy regions during the second half of the season. While it is only one year this is an excellent result and indicates that for many it is the start of recovery, and for others a continuance of solid farm performance.  

What is Earnings before interest and tax (EBIT) per kilograms of milk solids?

The Dairy Plan has generated a strong focus on profitability and industry discussion about measures and targets, including why EBIT/kg MS is used as a key measure of farm profitability in addition to another commonly used metric RoTA (also called Return on Capital).

Dairy Australia Managing Director David Nation explained why EBIT/kg MS was included as a profitability measure to assist with farm business planning and to track national profitability trends.

“EBIT/kg MS was selected in consultation with farm business advisers as a measure that resonated most with farmers and was aligned to the main product for which they get paid (kg MS). It has allowed us to establish a national base line for farm profitability, that will enable us to track profitability trends over time.

“There is a debate about whether RoTA should have been the only measure of profitability. From our perspective it’s not an either or conversation, because the Dairy Plan incorporates profit goals for both EBIT/kg MS as well as a RoTA target of 5%.

“EBIT/kg MS allows easier comparison across different farms and different regions as return on total assets varied significantly, depending on the value of farmland – which is related to external factors rather than the performance of the business itself.”

Helen Quinn, Farm Business Data Lead at Dairy Australia, helped to produce the ‘Measurement of profitability on Australian dairy farms’ report included in the Australian Dairy Plan.

“While RoTA enables comparison of profitability across farms and regions, because it takes into account the difference in quality of resources available to dairy farm businesses, it is also a subjective measure – as valuing the capital base relies on the subjective assessment of the market value of assets."

“EBIT/kg MS is however a much more objective assessment as there is only one way to calculate the measure that is widely accepted across the Australian dairy industry. It therefore means all dairy businesses can accurately assess their profitability against the target measure.”

“We chose EBIT/ kgMS to provide the industry with a measure that directly reflects the ability of a dairy farm to generate profit. We are seeing EBIT/kg MS being received and understood by farmers better as a measure that is more relatable to their farms, systems and conditions. We landed on using a term that is more relatable to farmers as a key indicator to track industry trends, though not in isolation as mentioned.”

Dr. Nation said that the Dairy Plan sought to create a new profitability measure that could be used universally across the industry, as RoTA wasn’t well used by farmers.

“RoTA provides a true economic view of farm financial performance, which is important to economists. However, our experience has been that farmers don’t relate to it easily and that it hasn’t become widely used in discussions between farmers. It is dependent on the value of the assets, which made comparisons across regions difficult. You can have very different land values and great differences in the perceived value of farming assets.

"If there isn't a consistent approach to understanding that and interpreting that, it would lead to an incorrect assessment of the return on assets. It would mean you aren't comparing apples with apples."

“Our focus is on building the capability across the industry to analyse farm financial performance on the basis of cash, profit and wealth. Based on the well established Dairy Farm Monitor Project method, DairyBase and our Dairy Farm Business Analysis training program which are aligned with this approach.

“We’ve tested it in the field with many farm businesses and have evaluated their feedback and found high levels of engagement. We want the focus on profit to succeed and will continue to do our best to both drive increased profit and measure it,” Dr. Nation said.

Improvement in farm profitability during 2019/20

A turnaround in seasonal conditions in the second half of last season in many dairy regions are being reflected in improved results for farms monitored by Dairy Australia’s Dairy Farm Monitor Project.

Results for Victoria and preliminary figures for NSW and WA show significant improvements in farm profitability for the 2019/20 season, despite poor seasonal conditions in some regions.

In Victoria, the average return on total assets (RoTA) increased, from 0.7% in 2018/19 to 5.4% in 2019/20. Farms were able to lower their costs, and with a 17 per cent increase in milk price, EBIT was $1.68 per kilogram of milk solids (kg MS).

In NSW, the preliminary 2019/20 data shows similar progress with an average EBIT $1.05/kg MS, compared to $0.38/kg MS achieved the previous year. The average RoTA also increased, up to 2.7% from 0.7% in 2018/19.

In WA, the preliminary 2019/20 data shows a lift in farm performance with an average EBIT of $1.41/kg MS in 2019/20 up from $1.16/kg MS in 2018/19. RoTA also increased to 3.9%, up from 3.2% in 2018/19.