Department of Agriculture and Food Systems
Agribusiness Review - Vol. 9 - 2001
Profitability of the Australian Beef Industry: A Break-even Analysis
Chinna A Kannapiran
Profitability of the specialist beef production in the Australian Beef Industry is undertaken using a break-even model. The results reveal that during the financial years 1991-1996, the specialist beef producers were operating above the break-even level in the states of South Australia and to some extent in Queensland. They were operating marginally below the profitable break-even level in the states of New South Wales and Tasmania. In all other states and Northern Territory, they were facing losses and financial crisis. However during the financial years 1993-1998, the beef producers in Queensland, South Australia, Northern Territory and Western Australia were able to cross the break-even level. Beef producers in all other states continue to face financial crisis. In all the states and Northern Territory beef producers were not able to fully recover the imputed value of their family labour. The producers were underpaid entrepreneurs and the industry is apparently surviving by trading on capital and or other off-farm income. Increase in production and cost control measures are possible options to improve the profitability. Although the findings provide a view of financial profitability of the specialist beef production in general, the situation may be different in specific cases. The study also reveals the usefulness of the break-even model in management decision support.
Keywords: Agribusiness, Australian, Beef, Industry, Profitability
This research was conducted when the author was a Research Economist with North Australia Research Unit, Research School of Pacific and Asian Studies, The Australian National University. The research was benefited by the comments and suggestions of Dr Ron May and Prof. Ronald Duncan of RSPAS-ANU and the participants of a seminar held at NARU-ANU. The comments by two anonymous referees are acknowledged. The usual disclaimers apply.
Australia is the world's largest net exporter of beef. Annual beef export income is around $ 3.3 billion with 60 per cent being derived from northern Australia. The total value of Australia's annual beef production is approximately $ 4.4 billion. While the cattle numbers have remained relatively stable (25 million heads since 1980), the beef production over this period has expanded by 30% and exports by 50%, highlighting a significant productivity gain in the industry (Meat and Livestock Australia (MLA) 1999a; Cattle Council of Australia 1999). Over the years, the industry has substantially changed its focus of production and financial performance. The beef industry has to adjust to cope with the financial, economic and market pressures caused by drought, falling market prices, competition in export markets, economic downturn in Asia, food safety scares overseas and increased competition from alternative protein foods (Martin, Riley, Jennings, O'Rourke, and Toyne 1998).
Beef producers, according to the Meat and Livestock Australia, are looking for a profitable and sustainable beef industry. A draft Beef Industry Strategic Plan 1999/2000 to 2001/02 presents the strategy to improve business management skills and capability to prosper in a competitive environment and to assist the industry in the development of key performance indicators for the individual businesses (MLA 1999b).
The present study was undertaken to evaluate the profitability of the beef industries in all states and Northern Territory during the periods 1991-92 to 1993-94 (Martin et al. 1998) and 1995-96 to 1997-98 (Riley, Martin, Lubulwa and Gleeson 2000). The purpose of the analysis is to support producers and planners by providing empirical evidences of profitability of beef industry and an appropriate management decision support model. A brief introduction of the Australian beef industry is available in section 2. Sections 3 and 4 present detailed discussion on the theoretical background for the break-even model analysis and its application as a management decision support tool in making decisions on production, pricing, risk management, turnover, profit planning and cost management. Sections 6 and 7 discuss the results of the analysis and illustrate the usefulness of the break-even analysis as an effective management decision support tool.
The Australian beef industry is comprised of approximately 60,000 producers of whom 20% account for 74% of production (CSIRO 1996). There are approximately 19,900 specialist beef properties in Australia, carrying 60 per cent of the Australian cattle herd. These specialist beef enterprises range in size from an average of less than 250 ha in the State of Victoria to more than 350,000 ha in the Northern Territory (NT). There are a further 28,700 properties in Australia that carry a mixture of sheep, cattle and crops (ABARE 1998). The beef industry contributes between 11 and 19 per cent per annum of Australia's gross value of agricultural production. It also plays an important role in regional economic development. Australian beef cattle production can be classified into two categories. In North Australia which includes Northern Territory and the northern regions of Queensland (QLD) and Western Australia (WA), cattle production is extensively undertaken in large cattle stations, grazing on native pastures at very low stocking densities. Their products are mainly beef destined for the United States (US), lot-fed beef and live cattle exports.
In the south, cattle are grazed more intensively on smaller farm holdings sown with introduced pastures and fodder crops. The industry here supplies smaller, younger animals chiefly for the Australian domestic market and higher quality stock for the Japanese market. While pasture-fed production dominates the Australian industry, the use of feedlots has developed dramatically since mid 1980s. Feedlot production involves feeding cattle high protein feed for periods ranging from 60 to 300 days to achieve specific market requirements. Feedlots exist in both the north and the south of the continent, close to grain-growing areas. This sector provides high-quality marbled beef aimed primarily at Japanese consumers. Australia now has a feedlot capacity of around 851,000 head with over half of that contained in Queensland and one third in New South Wales (NSW). According to Meat and Livestock Australia (MLA 1999c) ‘Queensland is the major cattle-producing State with 38 per cent of the nation's cattle population followed by New South Wales (24.9 percent), Victoria (16.9 percent), Western Australia (7.5 per cent), the Northern Territory (5.6 per cent), South Australia (4.5 per cent) and Tasmania (2.6 per cent)'.
Financial analysis measures the profitability using the market (financial) price for inputs and outputs and facilitates investment decisions of private sector or commercial investment of public sector. In contrast, economic analysis measures economic profitability using the shadow prices or the opportunity costs which may be different from their prices in the market and facilitates public sector investment decisions and public policy analysis (Gittinger 1982; Ward et al. 1991). Financial analysis is concerned with the return to the contributors of capital, and shows the profitability to the investors. Economic analysis reflects profitability from the viewpoint of the economy, and is concerned with the flow of real resources (hence, any transfer payments are excluded and time value of money accounted). Financial analysis is most appropriate to evaluate the private firms, public commercial investment and the industry as a whole and without financial profitability no industry can attract private investment. Similarly, the beef industry in Australia must be financially attractive to entrepreneurs and therefore the present study is undertaken to evaluate the financial viability of beef industry and is focussed on specialist beef producers in Australia.
Break-even analysis (BEA) is a financial analysis tool that provides one of the most useful decision models for financial management decisions (Ketz et al. 1991). It facilitates decision making in the short term, although long-term and strategic decisions can also be made based on BEA and it can assist in making investment decisions that are both technically and financially sound (Short and Lung 1996). Break-even point is simply the level of sales that a business must generate to achieve zero profit and or zero loss (cost recovery point); a business operating below that point for any length of time will fail.
Theory of firms provides the link between the economic theory and the break-even analysis. Classification of costs into fixed and variable component is necessary to understand the theoretical analysis. The total cost (TC) of a firm is classified as fixed costs (FC) and variable costs (VC). FC primarily consists of "overhead expenses" that firm incurs even if a product is not produced (Zero production) or no sales are made and therefore remain constant regardless of the level of production (e.g. salaries of management staff (not direct labour), rents, rates, taxes, leases, utilities, insurance, advertising). The total fixed cost curve is always horizontal because it does not change with output changes (Baumol et al 1988). VC changes in direct proportion to a change in the number of units sold or produced (include raw materials, direct labour, direct expenses (i.e. cost of goods sold). When the FC remains constant, the VC is the marginal cost per unit of production and the sale price (P) per unit minus VC remains as the contribution (C =P-VC) to recover the FC.
Applying these theoretical rules, the BEA is used to evaluate the financial viability of the beef industry. BEA is a powerful decision-making tool in determining cost recovery price, level of production and profit and in the preparation of forecasts and budgets, and in budgetary control of expenses. It reveals how changes in sales and costs will affect profits and the financial risks associated with price and quantity variability. BEA can help management to simulate the effects of alternative management decisions on costs, profits and financial performance (Welsch, Hilton and Gordon 1988). By adding a planned profit to the fixed cost, BEA can determine the production or sales required (in dollars or units) to cover costs and achieve or maintain that desired level of profit. The resulting break-even volume becomes the target volume necessary to achieve the firm's profit objective (Kannapiran 1989; 1982).
Some of the basic assumptions of BEA are listed below (Ketz, Campbell and Baxendale 1991):
At break-even point, the total income equals the total expenditure or the total revenue equals the total costs. A pure enterprise generates income from a single output or product and therefore, the costs and revenue can be easily identified and allocated to the product as in break-even equation 1:
Where Q is the quantity (units) produced or sold and P is the sale price per unit produced or sold, FC is fixed cost for the enterprise and VC is the variable cost per unit of production or sale (Van Horne 1983). In a mixed enterprise with multiple products and sources of income (beef, sheep, crop etc), the break-even equation must be modified to account for other income and expenditure on production of products other than the main product.
Where OI is the sum of other income and OVC is the sum of other variable cost. FC is allocated for the whole enterprise. Equation 2 (Eq. 2) can be articulated in a variety of ways to evaluate alternative choices for strategic and operational decision making in an enterprise (Ketz, Campbell and Baxendale 1991) as discussed below.
Production decision: To determine the production quantity in order to recover the given costs (fixed and variable) at the prevailing price of output, Eq.2 must be solved for Q. The estimated Qe, which is also known as the break-even quantity (units of the major product), can be estimated for a given level of price and cost structure (Eq.3):
Where (P – VC) is contribution or profit margin per unit (Hilton 1994) and Qe is the estimated or break-even quantity. The contribution per unit (sale price per unit minus variable expense per unit, i.e. P – VC) is the available income (or contribution) to recover fixed expenses. The fixed cost is then divided by the contribution per unit to determine how many units (break-even quantity) the firm must produce and sell to pay for fixed expenses. The break-even quantity indicates the number of units that must be produced and sold to cover all expenses.
Pricing decision: The break-even price (Pe), below which the enterprise will not be able to recover the given costs, can be estimated by solving Eq.2 for P.
Where Pe is the break-even or estimated price. When the market price goes below this level, then there will be no full cost recovery and the enterprise incurs loss.
Risk Management Decision (Safety Margin Analysis): Safety margin or margin of safety analysis reveals the difference between the planned (budgeted or actual) sales and the break-even sales (Hilton 1994; Meredith 1994). It suggests to the management how close to the breakeven sales or production point the enterprise is operating (Welsch, Hilton and Gordon 1988). It essentially calculates the extent (or percentage) of decrease in sales quantity or price an enterprise could suffer before it began to operate unprofitably. Safety margin can be expressed in terms of quantity (Q - Qe) and or price (P - Pe).
Turnover decision: The total sales volume or income required to recover all the costs can be determined by multiplying the break-even price (Pe) and break-even quantity (Qe).
Break-even sales volume or income = Pe x Qe
Profit Planning Decision: All business enterprises desire to make a profit and not just break even. A desired or planned profit (payment to the entrepreneur) should be added to the fixed cost. This reduces the gross profit, which in turn raises the break-even volume. The resulting break-even volume thus becomes the target volume necessary to achieve the firm's profit plan (Meredith 1994). After adding a planned profit to the fixed cost amount, the BEA can be re-estimated to determine the break-even P, Q and SM for the revised FC (plus profit). The sales price per unit or the sales quantity required (units) to cover costs and achieve or maintain that desired level of profit can be determined (Kannapiran 1982, 1989).
Cost management decision: The tolerable level of fixed cost (or the maximum limit for the fixed cost), that can be recovered for the given level of production, variable costs and price, can be estimated by multiplying the contribution or profit margin (PM) per unit by the actual quantity produced (Q).
Tolerable fixed cost = PM x Q
While the break-even point indicates the level of profitability, other estimated parameters provide reasons for that level of profitability.
The main source of data for the present study came from Martin et al. (1998) and Reily et al. (2000). The survey contains data for monitoring the financial performance of beef producers in all the states and Northern Territory of Australia. The survey focussed on specialist beef producers. Five years average data for the financial year ending 1995-96 and 1997-98 were used to carry out the BEA of the specialist beef producers. The analysis based on five years average data for two periods is expected to provide the consistency of performance of the industry over the years. The data was classified into fixed costs (administrative cost, rents and taxes, repairs and maintenance, depreciation, debt servicing etc.), variable costs (cost of beef cattle purchased, freight, handling and marketing, feed and fodder costs etc.), other variable costs (cost of production for activities other than beef) and beef income and other incomes (income from sources other than beef).
A special mention must be made about the treatment of depreciation. Although depreciation is a non-cash expenditure in a particular year, it accounts for recovery of the capital invested already and or a deferred expenditure resulting from amortization of the capital expenditure already incurred. Failure to treat depreciation as cost leads to a situation of ‘trading on capital'. All business enterprises aim at ‘return of capital (recovery of capital invested)' and ‘return on capital (income from the capital investment)' (Gittinger 1982). In marginal cost analysis, like BEA, depreciation is a deferred cost to recover the capital invested (return of capital). It must, therefore, be treated as a fixed cost. This convention has been adhered to in this study.
A break-even model (Eq. 1 - 4) of the Australian Beef Industry was developed and used in the present study. The model was articulated and estimated to obtain various results to evaluate the financial viability and to assist beef producers in making decisions on production, pricing, risk management (safety margin), cost control and profit planning. The results of the study are presented for the five years period ending in financial years 1995-96 and 1997-98 (see Table 1 and 2 and in figures 2 to 10). The break-even charts for all the states and NT are available in figures 4-10. The effectiveness of the model as a management decision support tool has been illustrated in this paper. The main findings of the study are briefly discussed here.
The results of the financial analysis of the Australian beef industry (Specialist Beef producers) undertaken using the break-even model are presented and discussed in this paper. Several interesting conclusions can be drawn from the results:
According to CCA (1999), the obvious advantage of cheaper production costs of Australian beef is lost by the less cost competitive marketing chain. ‘Without benchmarking the whole production - transport - processing - marketing chain, it cannot be determined exactly where the greatest pay-offs from improving efficiency will come from' (PIRSA 1995). The present study does not evaluate the efficiency of the marketing chain. However, if it were proved that an inefficient marketing chain was one the major causes for the financial crisis in the beef industry, then the transport, processing and marketing sector reform must be a priority in public policy.
Although the findings provide a view of financial profitability of the beef industry in general, the situation may be different in specific cases. Moreover, an assessment of overhead costs and the level of capitalisation are necessary to justify the debt servicing and the current capital structure that might have adversely affected the break-even points. The limitation of the present break-even analysis is that it assumes that all output is sold at a given level of production. This problem could be avoided if the net sales are considered instead of the output. Another limitation is that the costs are assumed as linear but in reality some components of costs are non-linear. Although non-linearity is not seriously affecting the results, a combined regression-break-even model (Kannapiran 1982) will minimise the problem of non-linearity.
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Table 1. Results of Break-even Analysis of Australian Beef Industry
for the Financial Years: 1993-94 to 1997-98
 According to a definition by the Australian Bureau of Agricultural and Resource Economics - ABARE (Martin, P. et al. 1998), the specialist beef producers are those producers mainly involved in running beef cattle.
 Conventionally, the term ‘economic analysis' includes both financial and economic analysis.
 Australian beef producers are price takers in the market and, therefore, they do not make the pricing decision. However, the break-even price suggests to the producers the profitable price.
 In the present case the imputed value of family labour cost is used as the minimum desired profit for the enterprise.
 In terms of production quantity, NT ranks first followed by SA, QLD, WA, NSW, Tasmania and VIC.
Date Created: 04 June 2005