Profitability rises in sight

Cost inflation is soaring, but commodity prices are leading the way, Campbell Wood writes.

In Business4 Minutes

Cost inflation is soaring, but commodity prices are leading the way, Campbell Wood writes.

We are in a period of high uncertainty with inflation and commodity prices. The importance of budgeting during this time is twofold.

First to understand future cash flow requirements and being proactive with the bank if requiring additional seasonal cash flow support.

Secondly the impact any movement in prices has on your taxable position. For some farmers that don’t complete budgets, the amount of tax to pay next season may come as a surprise.

Although costs seem to keep increasing, on average profitability is still outstripping increased costs. For example, in April 2020, the lamb schedule was $6.25/kg, so a 18kg lamb $112.50, beef schedule was $3.93, so a 270kg carcase $1061.

Fast forward to 2021, these prices were $6.65 for lamb, so $119.70 per lamb, and $4.43 for beef, so $1196.1 per head. This season, we are sitting at $8.20/kg for lamb in Southland, $147.60 per head, and $5.60/kg for beef, so $1512 per head.

So in real terms, a 5000 stock unit sheep and beef operation income could be up $160,000 this season.

On the costs, for comparison, in 2020 diesel was $1.21/litre, 2021 $1.48/l, and at the time of writing this the price at the pump was $2.16/l. The price of urea was in 2020 $575/tonne, 2021 $674/t, and now $1270. These are just two examples in a long list of costs continuing to go up. From what we have seen, overall costs so far this season have increased 15-20%, so between $10-15/stock unit.

A lot of people have the mind-set that costs will have outstripped increased income, however this is not the case for most farmers.

So far over the past month or two everyone I have revised numbers with, is sitting about $20/ stock unit better than last year in terms of operating surplus. This represents between $5.60-$6.60 in extra tax per stock unit depending on the structure. This is consistent across our client base and some of the discussion groups we facilitate.

It is important to be proactive with this in your planning before next season, and set some of this year’s surplus towards paying this tax, so you can start next season fresh, as who knows where things may end up next year. By regularly reviewing budgets, farmers should be either increasing provisional tax instalments to allow for the extra tax, or be budgeting for a larger terminal tax payment in the following season.

Inland Revenue assesses the provisional tax on the previous season’s profit and then adds a further 5% for inflation. We recommend that if cash flow allows, pay more than the provisional tax requirements and pay tax according to your budget. You can only do this if you regularly update your budgets and compare them to your actuals.

As always, it is important to understand your business and what your bottom line looks like so you can make proactive decisions at the right times. If the red meat market was to drop, each farmer should know well in advance the effect on their cash flow.

  • Campbell Wood is an accountant for Agrifocus, Invercargill.