Most computer modeling programs give you an idea of either the biological aspects of production or the financial side. But the Return on Equity model shows both sides of the coin.
The ROE model combines your production information with your banker's financial information to show you the big picture of your operation. This lets you see how each change affects your return on equity, return on assets and return on investment.
It gives producers a sound understanding of the effects of improving management or changing price structures on the financial health of their businesses, says Will Marsh, president of FarmWise Systems.
The ROE model helps you understand the importance of managing the profit margin in tandem with managing throughput.
The program makes some adjustments automatically, while others must be entered in. For example, if you increase pigs per litter, the program will automatically adjust the amount of feed you need to buy. However, it won't make space adjustments in the finisher. But with proper training and guidance you will know when to make these adjustments, says Marsh. Changing underlying cost and market price assumptions are straightforward and indicate changes in business cash flow.
The ROE model may be used in conjunction with the National Pork Producers Council's benchmarking database to show how changes in production may change your percentile ranking in the database.
The model is independent of any recordkeeping system, so you should be able to get information regardless of what recordkeeping system you use.
There are four major input categories in the ROE program:
- Animal Flow
For a breeding herd you would need to enter in the number of breeding females, then the number of pigs per sow per year, typical replacement rates and pre-weaning mortality rates to determine the number of pigs transferred to the nursery in an operating year. You then take nursery and grow/finish mortality rates and the days needed to reach benchmarked weights to determine your pig flow.
- Feed Budget
The program can handle up to 10 diets per growth phase and will calculate into the feed budget. If your production is on a large enough scale the program can look at barrows and gilts separately.
- Balance Sheet
The program already knows the inventory of growing pigs from the feed budget, so it has an idea of your current assets. You will need to detail your non-current assets, such as breeding herd depreciation, buildings, equipment and space. On the other side of the balance sheet, you detail your current liabilities and long-term debt structure.
- Allocate non-feed costs according to production
There are two approaches to this stage. You can work at the total pork level and take a commodity point of view; or you can allocate your non-feed costs across production stages.
For example you would take your veterinary bill for a year and decide what percent of that bill is allocated to breeding herd, nursery and grow/finish, says Marsh.
You can then use these inputs to get a detailed income statement for the year that can be broken into a per-head or per-hundredweight basis for the finisher.
After you have all that information, the ROE model kicks in showing you the affect of production changes on your return on equity. For example, you could see how a 3 percent change in feed expenses would affect your cost of producing each pig, the return on assets and return on equity.
Marsh says the ROE model was designed for continous-farrowing systems, but can be modified to fit most systems by inputting the correct data.
The ROE model works for any producer who wants to understand his or her cost structure. Most producers generally get more benefit from the program if they sit down with someone who knows what they're doing ahead of time, he says. It takes two to three hours to set up the program and enter the correct data.
As with any modeling program, if you don't have accurate records you can't get very far with the ROE model.
You also can use the spreadsheet format to set a goal and work backward, identifying changes needed to meet that goal. For example, you could use it to find breakeven prices.
The ROE model is built on a spreadsheet in Microsoft Excel 5.0. To run the program you need Windows 95 and Excel 5.0 or higher. It has about 15 total input and output screens.
Economist Dennis DiPietre and veterinarian Rick Tubbs originally developed the program at the University of Missouri. You can purchase it for $49 plus shipping and handling. To order the program or to receive more information, call Jenny Felt at NPPC, (515) 223-2600 or Marsh at (877) 474-4946.
If you want to get a clearer picture of your entire operation from the farrowing house to your bank account, the ROE model may be for you. It is one more tool you can use to make informed decisions to raise pork more profitably.
What is Return On Equity?
Return on equity is driven by two primary factors: return on assets and use of debt.
Return on assets is a measure of how well a business is functioning and is calculated by taking asset turnover multiplied by net profit margin as a percent of sales. Asset turnover is the total sales divided by the asset value.
For example, a business with annual sales of $1 million, an asset value of $500,000 and a net-profit margin of 7 percent would have a ROA of 14 percent. (1,000,000 500,000 x 0.07.)
To improve ROA you must either increase margin or turnover. To increase turnover you can increase sales volume, liquidate unnecessary or obsolete inventory, dispose of unused fixed assets, speed up collection of receivables or evaluate credit terms.
You also can increase ROE by increasing the percentage of assets financed by debt. Increasing debt can increase ROE, as long as the gross return on assets exceeds the cost of debt. But when debt increases the business risk position also increases.
Using debt can improve profitability, up to a point. It is cheaper than using equity as long as the risks to the lender aren't so great that higher interest rates are required to account for the risk.
If you use effective risk-management tools then you can take on more debt, increase leverage and increase your ROE. The lower the business risk, the more debt a lender would be willing to provide and the higher your ROE.