Business Management Session 2 Management Accounts

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Business Management Session 2Management Accounts
2
Management Accounts

• Overview of areas to cover
• Variable, overhead, capital costs and receipts
• Depreciation
• Gross margin and net margin
• Focus on individual farm enterprise rather than
  whole farm business

3
Tax versus Management Accounts

• Purpose of tax accounts - to calculate the farm
  business profit, which determines the amount of
  tax due
• Purpose of management accounts to measure
  efficiency of individual farm enterprises and
  whole farm
• Neither tax or management accounts include VAT

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Classification of costs
EXPENSES (Money flowing out of the business)
Variable Costs
Overhead Costs
Capital Costs
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Variable Costs

• A farm enterprise is a component of a farm
  business. E.g. A farm may include an arable
  enterprise and a dairy enterprise.
• Variable Costs relate entirely to a particular
  enterprise and vary in direct proportion to the
  size of the enterprise e.g. meal.

• Examples
• Concentrate or meal
• Vet and medicines
• Bedding materials
• Dairy chemicals
• Ear tags
• Liners (routine replacement)
• Forage costs (fertiliser, spray, silage
  additive)
• etc.

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Overhead Costs (Fixed costs)

• Costs that cannot easily be allocated to a
  specific enterprise and do not vary
  proportionately with changes in the output of the
  farm. Sometimes referred to as Fixed Costs.
• Examples
• Machinery running costs
• Contractors
• Farm Electricity and Water charges
• Wages, National Insurance Contributions (NIC).
• Conacre
• Property repairs, minor land works including
  drainage
• Finance charges (not the capital portion)
• Depreciation (will be covered in more detail
  later)

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Capital Costs

• Assets purchased that last over a long period of
  time
• Examples
• Buildings
• Machinery purchase
• Laneways
• Land improvements e.g. Fencing, drainage,
  planting hedges
• Purchase of land

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Depreciation

• Spreads the initial cost of a capital item over
  its economic lifetime.
• Shown in year-end accounts as an overhead cost to
  the business but is not physically paid out.
• Two methods
• Reducing balance e.g. machinery
• Straight line e.g. buildings and land
  improvements

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Reducing Balance Depreciation

• The items value is continually reduced by a
  fixed percentage each year.
• Used for machinery two rates used for
  CAFRE Benchmarking
• 25 for self-propelled machinery (tractors,
  quads etc.)
• 15 for non self-propelled (trailers, tanker,
  mower etc.)

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Reducing Balance Depreciation Example

• A tractor is purchased at 50,000
• The value is reduced (depreciated) by 25 each
  year.

Year
Opening
Dep. Rate
Dep.
Closing
Value
Amount
value
37,500
Year 1
50,000
25
12,500
28,125
Year 2
37,500
25
9,375
Year 3
28,125
25
7,031
21,094
15,821
Year 4
21,094
25
5,273
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Straight Line Depreciation

• The items initial value is reduced by a fixed
  percentage each year.
• Used for buildings and land improvements
• 10 per year
• i.e. Asset is written off the books after 10
  years

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Straight line Depreciation Example

• e.g. A new silo built at 40,000
• The initial cost is reduced (depreciated) by 10
  of the initial value each year for 10 years (e.g.
  4,000)

Year
Opening Value
Dep. Cost p.a.
Closing value
Year 1
40,000
4,000
36,000
Year 2
36,000
4,000
32,000
Year 3
32,000
4,000
28,000
Year 4
28,000
4,000
24,000
Year 10
4,000
4,000
0
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Depreciation is not Cash

• Depreciation is a notional expense
• The actual cash payment may have to be covered in
  1 year, while the depreciation is spread across
  several years.
• (Difference between Cash and Profit covered next
  week)

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Costs Exercise

• The following items are examples of common
  expenses on the farm. Decide which type of cost
  it is and record your answer by ticking the
  appropriate box.

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Costs Exercise
Variable
Overhead
Capital
Cost
Cost
Cost
Milk liners
ü
Concentrates
ü
Farm Insurance
ü
Repairs
to roadway
ü
Vet bill
ü
AI Costs
ü
Machinery repairs
ü
Purchase of Landrover
ü
Grassland sprays
ü
Auctioneers fees
ü
Telephone bill (farm)
ü
Purchase of Milking Parlour
ü
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Classification of Receipts
RECEIPTS (Money flowing into the business as
income)
Capital Receipts
Enterprise Receipts
Sundry Receipts
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Receipts

• Examples
• Enterprise receipts
• Milk cheque
• Money for calves sold at market
• Cheque received for cull cows sold
• Money for replacement heifers not needed and sold
  off
• Sundry receipts
• Cheque from neighbour for contract work e.g.
  spreading slurry, cutting hedges etc.
• Single Farm Payments, CMS, LFACA
• Capital receipts
• Cheque for sale of tractor
• Money from sale of land/site

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Why do I need to know how my business is
performing financially?

• To see if my farm business is financially viable
• To identify the most profitable enterprises
• To make better management decisions

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Enterprise Gross Margin and Net Margin

• Enterprise Gross Margin
• Enterprise output less variable costs
• Used to identify individual enterprise
  performance i.e. technical efficiency
• Takes account of
• enterprise expenses
• enterprise receipts
• transfers
• valuation changes
• It is NOT a measure of profitability as it does
  not include overhead costs

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Example of a Dairy Cow Enterprise Gross Margin
by cow, hectare and pence per litre
This year 2013/2014 This year 2013/2014 This year 2013/2014
PPL /Cow /Ha
Output      
Milk Output 33.23 2,723 5,612
Calves 1.95 160 331
Less Replacements -2.05 -168 -347
Total Output 33.13 2,715 5,596
Variable Costs      
Forage Costs 1.49 122 252
Concentrates 8.19 671 1,383
Vet/Medicine 1.71 140 290
Breeding Costs 0.51 42 87
Sundry Costs 1.39 114 236
Total Variable Costs 13.29 1,089 2,248
Gross Margin 19.84 1,626 3,348
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Example of a Dairy Cow Enterprise Gross Margin
by cow, hectare and pence per litre
This year 2013/2014 This year 2013/2014 This year 2013/2014
PPL /Cow /Ha
Output      
Milk Output 33.23 2,723 5,612
Calves 1.95 160 331
Less Replacements -2.05 -168 -347
Total Output 33.13 2,715 5,596
Variable Costs      
Forage Costs 1.49 122 252
Concentrates 8.19 671 1,383
Vet/Medicine 1.71 140 290
Breeding Costs 0.51 42 87
Sundry Costs 1.39 114 236
Total Variable Costs 13.29 1,089 2,248
Gross Margin 19.84 1,626 3,348
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Exercise 100 Dairy Cow Enterprise Gross Margin

• Milk sales 210,000
• Calf sales/transfers 15,000
• Less Replacement costs - 17,500
• Total output ________
• VARIABLE COSTS
• Forage costs 15,700
• Concentrate costs 70,000
• Vet medicine costs 7,100
• Breeding costs 3,000
• Sundry costs 9,500
• TOTAL VARIABLE COSTS ________
• ENTERPRISE GROSS MARGIN ________
• 100 Cow herd divide by100
• GROSS MARGIN PER COW ________

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Answer 100 Dairy Cow Enterprise Gross Margin
Milk sales 245,000 Calf sales/transfers
15,000 Less Replacement costs - 17,500
Total output 242,500 VARIABLE COSTS Forage
costs 15,700 Concentrate costs 70,000 Vet
medicine costs 7,100 Breeding costs
3,000 Sundry costs 9,500 TOTAL VARIABLE
COSTS 105,300 ENTERPRISE GROSS
MARGIN 137,200 100 Cow herd divide
by100 GROSS MARGIN PER COW 1,372
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Exercise Dairy Cow Overhead Costs
Machinery and building depreciation 19,000 Machi
nery running and contractor costs
16,500 Property repairs 3,500 Electricity,
Water Rates 4,000 Business admin
costs 2,000 Paid Labour 4,500 Conacre 6,500 Fin
ance 1,500 TOTAL OVERHEAD COSTS 57,500 100
Cow herd divide by100 TOTAL OVERHEAD COSTS
per cow 575
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Net Margin

• Enterprise Gross Margin minus enterprise Total
  Overhead Costs
• Indicates the profitability of the dairy herd
  enterprise
• e.g. If total overheads are 575 per cow the Net
  Margin per cow in our example would be
• GROSS MARGIN PER COW 1,372
• Less Total Overheads per cow 575
• NET MARGIN PER COW 797

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Profit

• The sum of all farm enterprises Net Margins
• Should also include subsidy payments
• Gives an overall farm profit figure
• Out of this profit the business must cover
• Tax
• Drawings
• Reinvestment

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Summary points

• Variable costs Relate entirely to a particular
  enterprise and increase in direct proportion to
  the size of the enterprise e.g. dairy meal.
• Overhead costs Costs that cannot easily be
  allocated to a specific enterprise and do not
  vary proportionately with changes in the output
  of the farm, e.g. Machinery running costs.
• Capital costs Costs spent on assets that last
  over a longer period of time e.g. Major building
  renovations, land purchases.
• Depreciation Spreads the initial cost of a
  capital item over its economic lifetime. Land
  and buildings - straight line depreciation over
  ten years. Machinery reducing balance method
  either 25 or 15 annual reduction.

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Summary points

• Profit can be split down into enterprise gross
  margin and enterprise net margin which can
  benefit decision making on the farm for the
  individual enterprise.
• Gross Margin output variable costs (feed,
  fertiliser, vet med etc.)
• Net Margin Gross Margin - overhead costs
• Overall Farm Profit is when all receipts and
  costs have been accounted for all farm
  enterprises. This is what the farm has left to
  pay tax, drawings and reinvest.

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Link to next lesson

• Benchmarking
• Gross and Net margins are the basis for the
  benchmarking report. A good understanding of
  these is essential in understanding and analysing
  a benchmarking report
• Cash and Profit
• While business performance is important,
  businesses also need to ensure cash is available
  to pay the bills. Planning and control of cash
  flow is an essential part of business management