By Michael Stapleton
I have no spur
To prick the sides of my intent, but only
Vaulting ambition, which o’erleaps itself,
And falls on th’other. . . .
These were Macbeth’s words as he prepared to murder Duncan, his king. I think they capture the root cause of Murray Goulburn’s (MG) recent, well-publicised woes.
You can read about MG’s problems here. The short version is an ambitious 2016 financial year (FY16) business plan and earnings forecast underpinned a promise to pay their farmer suppliers a Farmgate Milk Price (FMP) of $6.01/kg of milk solids, a figure well above what international dairy prices would support. By February 2016 this forecast was under pressure and in April 2016 the business acknowledged it had no hope of achieving its forecast earnings or paying its suppliers anywhere near the opening FMP.
So, let’s take a look at the public information for MG and see what lessons there are for owners of small and mid-size businesses.
Australia’s largest milk processing company
MG is Australia’s largest milk processing business. It processes in excess of 37% of the total milk produced in Australia. It has more than 2,500 suppliers and employs more than 2,400 people. It is a recently listed business with processes in place to meet governance and reporting requirements. It clearly had a budget and a business plan.
Given these factors how did MG get FY16 so wrong?
Let’s start at the beginning
Consider these assumptions, which underpin MG’s FY16 earnings forecast, and are set out in its Product Disclosure Statement (PDS) of May 29, 2015:
- Milk intake of 3.65 billion litres;
- Revenue of $3.3 billion;
- FMP of $6.01/kg of milk solids;
- Commodity prices to increase over those prevailing at the date of the PDS, skewed to the 2nd half of FY16. MG expected to make a 3-6% premium on dairy commodity prices above the Global Dairy Trade benchmark indicator;
- Average foreign exchange rate of US$0.76; and
- Value Added product sales to increase to 74% of Total Sales (FY16).
Why is this information Important?
Firstly, if you compare these assumptions with recent history it guides you as to the scale of the task at hand. Imagine MG is your business. Your FY16 forecast revenue/litre of Milk received is $0.90c in FY16. This compares to $0.80c revenue/litre in FY15, and an average of $0.81c revenue/litre over the period between FY12 to FY15. Armed with this knowledge, you can now ask specific questions about the achievability of this increase.
Secondly, if you understand the key drivers of your budget you can establish a couple of financial and non-financial indicators to help you understand whether the business is on track to meet its plans. For example you could track the:
- Volume of milk intake each month;
- Revenue/litre of milk each month;
- Product mix each month;
- USD exchange rate; and
- Commodity prices.
The movement in these measures will inform you as to whether the earnings forecast remains based on valid assumptions, or whether it needs reviewing and possibly changing.
Interestingly, the Murray Goulburn FMP tracks the movements in international dairy prices quite closely until December 2013. The gap between FMP and international prices then widens precipitously, until February 16 and April 16, when real world conditions could no longer be ignored.
Currency on the other hand has averaged a touch under US$0.73, below MG’s assumption of US$0.76 and thus helpful to its business.
What are the lessons for owners of small and mid-size businesses?
First of all, it is rare that you will exactly hit your forecast. The forecast is (usually) a quite simple and logical mathematical expression of a chaotic and complex world. Anyone demanding 100% accuracy in forecasting does not understand the limitations or nuances of forecasting.
Secondly, a forecast is the financial expression of your business plan. The point of the forecast is that it gives you way-points against which to measure your progress. It allows you to ask questions, such as:
- Have we taken all the actions required to achieve our forecast?
- If not, why not? When will those actions be completed?
- If we have, then what has changed in the market for our goods/services that we did not anticipate?
- What, if any, action do we need to take as a result of the answers to these questions?
Thirdly, a forecast is a living and breathing document and should be reviewed regularly. Don’t be afraid to adjust or alter it to reflect changing real world conditions. As the owner of the business, the only person you are only fooling by not facing up to facts is yourself.
I think the last point is the nub of the MG problems. There was clearly an unwillingness to recognise that their forecast was unsustainable.
I say this because there were plenty of ways for the board and management to keep track of key forecast assumptions, and plenty of objective evidence that the FY16 stretch was difficult.
It is impossible to believe that a business that had operated for as long, through all manner of seasons, commodity price and currency conditions did not have the capacity to track its progress and understand that its FMP was too high much earlier.
What do you think?
Michael Stapleton is a founding member of the Association of Virtual CFOs. He operates a Melbourne-based Virtual CFO practice, helping owners of small and mid-size businesses understand the drivers of their cashflow and make financially informed decisions. Find out more about the Association of Virtual CFOs on LinkedIn.