Guidelines to implementing the transition plan
Aim to achieve the change from current practice to new enterprise targets in as short a time as possible. At the same time ensure that cash flow, business equity and liquidity stay within set limits. A process is required that tests, prioritises and sequences the project options to maximise return on investment of time and capital and annual business profit.
Initially, a wide range of scenarios can be reviewed for feasibility in a typical year. These are compared on a gross margin per hectare basis (additional returns minus additional costs). Then a partial budget analysis should be conducted for the options of most interest. This takes account of all the variations in returns and costs, including additional capital associated with the proposed change. It mirrors the whole farm budget but only accounts for those items that vary if this investment or option is adopted and implemented. The returns on the additional capital required are as important as the overall return on total capital.
When this initial screening is completed, it may be appropriate to consider a more detailed analysis, particularly where high capital outlay or longer timeframes are involved. Consider methods such as discounted net cash flow analyses, as the value placed on money changes over time – a dollar in the future is regarded as being worth less than current value. The discount rate chosen for ‘devaluing’ future returns is normally the assumed rate for borrowing, say 8%, plus an addition for risk, say 4%, giving in this example a rate of 12%. This is often referred to as a nominal discount rate because inflation is included.
If the changes involved in your transition plan are complex, with expenditure spread over several years, it becomes necessary to consider the whole farm budget over a number of years using different inputs of key variables. Predict future scenarios by considering how variables such as costs, returns, seasonal changes and family goals could impact on your plans, then use these scenarios to determine your risk management strategy. Select the most likely scenarios and analyse them for impact on the whole business cash flow, liquidity and ability to finance.
Comparing analysis approaches
The differences in outputs from partial budget analyses and discounted net cash inflow analyses are as follows:
Partial budget analysis outputs
• Net gain (returns minus costs)
• Percentage return on extra capital invested (such as in livestock)
Discounted net cash flow analysis outputs
• Net present value of the investment over the period of time (discounting the value of returns and costs in the future)
• Internal rate of return (that can be used to compare projected returns with the opportunity cost of investing the money elsewhere)
• Nominal net cash flow (inflation included)
• Cumulative net cash flow
Managing the risks
The main risks of transition are failing to gain the highest possible enterprise profit and taking longer than necessary to achieve enterprise profit goals, when:
• Management needs to have the knowledge and skills to manage change;
• Investments are not scheduled in order of highest rate of return on investment; and
• Enterprise changes are not planned to minimise cost and maximise returns.
A worst-case scenario is when the farm business is destabilised during the transition by declining beef enterprise cash flow. This may contribute to reduced equity and liquidity so that business commitments may not be met. Options available for addressing this include:
• Completing or re-calculating partial budgets, beef business and other enterprise budgets and cash flows to establish discounted rates of return. When implementing options, review all analyses and take the main constraints for business into account.
• Stopping or limiting progress on those changes with relatively low discounted rates of return and re-directing investment to business areas with the highest rate of return.
• Delaying or advancing implementation of the rate of change as cash flow and time constraints vary over time.
In other instances, the business equity can increase while having a decreased cash flow. This happens when the stocking rate is increased because sales are foregone and assets (herd numbers) are increasing.
Key variables, such as sales prices, that influence the outcomes should initially be based on long-term average values. Use a range of expected sale prices (eg expected average, best possible price, lowest likely price) to get an idea of the impact of possible fluctuations in your assumptions. Use this information to forecast sale price variability and potential risk.
What to measure and when
The following areas should be measured:
• Marginal return on investment for each project and option;
• Annual enterprise profit (return on capital);
• Yearly cash flow, business equity and liquidity.
The frequency of these reviews should be:
• Initially – before any major investment is made;
• Annually – as part of normal business and enterprise planning and cash flow budgeting cycles; and
• Periodically – before new projects are initiated to minimise costs and maximise returns.
