Profitability is broadly defined as the rate at which profits are generated from an investment. For our project, we use the rate of return on assets (ROA) to measure profitability. We define the rate of return on assets as net farm income from operations (NFI) plus interest on debt, minus a $50,000 charge for unpaid management, divided by average total assets. This is a useful measure because, when uniformly calculated, it is directly comparable between businesses because it is adjusted for differences in size. In fact, any business participating in the project can directly compare their profitability to any others that use Farm Financial Standards Council recommendations.

The rate of return on assets is also useful because of its characteristics. In the DuPont profitability model, the rate of return on assets is a product between the operating profit margin^[2] and the asset turnover ratio^[3]. For example, if a dairy had a 10% operating profit margin and an asset turnover ratio of 0.75, the rate of return on assets would be 0.10 X 0.75 or 7.5%. The operating profit margin measures the operating efficiency of the business or what portion of total revenues (what the business produces) is retained as profit. Conversely, the asset turnover ratio measures capital efficiency or how many dollars of revenue is produced from every dollar invested in the business. This relationship causes the rate of return on assets to be driven by both the operating and capital efficiency of the business.

The following table lists selected 1997 statistics for a sample of dairies participating in the project. The dairies were sorted into three groups based on the rate of return on assets. While the statistics that are presented in the table are based on operating conditions unique to Florida, several concepts are demonstrated that are important to any dairy business. Total revenues of $17.80 per cwt. milk sold and total expenses of $18.85 (low profitability group) were much higher in Florida than they may be in other Southeast states. However, business profitability is a measure that can and should be applied to any business regardless of location.

Several things are evident by examining the differences between profitability groups. First, you should notice the difference in operating efficiency by looking at the operating profit margin. The low profitability group (<1% ROA) had an average operating profit margin of -6%, the middle group (1%-9% ROA) had 8%, and the high group (>9% ROA) averaged 12%. In other words, there was an 18-percentage point difference in operating efficiency between the high and low profitability groups.

The reasons for the wide variation in operating efficiency were due to differences in both revenues and expenses. The high profitability group had total expenses of $17.09 per cwt. milk sold which was $1.76 lower than the low group at $18.85. The high profitability group also had higher total revenues at $19.03 per cwt. milk sold, $1.23 above the $17.80 total revenues for the low group. The middle profitability group fell between the high and low groups for both revenues and expenses.

The other difference between profitability groups was due to differences in capital efficiency. The asset turnover ratio was 0.72 for the low profitability group, 0.87 for the medium group, and 1.08 for the high group. This difference translated into the high profitability group generating $0.36 more revenues per dollar invested than the low group, a 50% difference in capital efficiency.

Several factors caused these differences. The high profitability group had the lowest assets per cow ($3,282), the highest milk sold per cow (18,113 pounds), and the highest total revenues per cwt. milk sold ($19.03). All of these factors are important in determining the asset turnover ratio. 

So what do these results have to do with dairy management? By definition, profitability is affected by both operating and capital efficiency. Decisions such as ration changes or equipment purchases directly affect the efficiency and profitability of the business. Upcoming articles will detail specific issues affecting dairy profitability. Expense levels will be investigated to understand different levels of cost control. Differences in revenues will show that farm productivity is more than just cash in the pocket. The composition of the assets of the business affects capital efficiency. Liability composition and level can also enhance or constrain profitability.

Those dairies participating in the project are able to directly compare their results to those presented in this and future articles. To find out more about the project, look up the Dairy Business Analysis Project on the web at http://dps.ufl.edu/DBAP. Here you will find more results, comparisons, and downloadable publications. You can also see if your dairy business is eligible to participate in the project. 

SELECTED FINANCIAL PERFORMANCE STATISTICS BY PROFITABILITY GROUP FOR 1997
Category	Rate of return on assets1
	<1%	1%-9%	>9%
Number of dairies	13	9	5
Number of cows	1,578	1,307	1,654
Milk sold per cow (pounds)	16,424	17,255	18,113
Assets per cow2	4,643	4,005	3,282
Total revenues (per cwt. milk sold)	$17.80	$18.64	$19.03
Total expenses (per cwt. milk sold)	$18.85	$17.34	$17.09
Net farm income3 (per cwt. milk sold)	$ - 1.12	$1.31	$1.94
Asset turnover ratio4	0.72	0.87	1.08
Operating profit margin5	- 6%	8%	12%
Rate of return on assets1	- 4%	6%	13%
1 Rate of return on assets is calculated by adding interest expense to net farm income from operations, subtracting a $50,000 charge for unpaid management, dividing the remainder by ending total assets. 2 Assets are the average of the beginning and ending values for each dairy divided by the average number of cows. 3 Net farm income from operations is computed by subtracting accrual adjusted expenses and depreciation from accrual adjusted revenues. 4 The asset turnover ratio is calculated by dividing gross revenues by average total assets. 5 The operating profit margin is determined by adding interest expense to net farm income from operations, subtracting a $50,000 charge for unpaid management, dividing the remainder by gross revenues.

[1] Manager, Dairy Business Analysis Project and Extension Agent, Department of Dairy and Poultry Sciences, University of Florida, Gainesville 32611-0920. Contributing authors include P. Miller, M. Sowerby, B. Tervola, D. Solger, P. Joyce, T. Seawright, C. Vann, and M. DeLorenzo. Also L. Ely, Animal and Dairy Science Department, University of Georgia, Athens 30602-2771
[2] The operating profit margin is determined by adding interest expense to net farm income from operations, subtracting a $50,000 charge for unpaid management, dividing the remainder by total gross revenues.
[3] The asset turnover ratio is calculated by dividing total gross revenues by average total assets.