Milk Production Management & Dairy Development

Module 16. Dairy Manufacturing Sector, Its Status and Problems

Lesson 31
ECONOMIC BURDEN PERFORMANCE ANALYSIS: INCOME AND EMPLOYMENT POTENTIAL

31.1 Introduction

This chapter Describes one of the case study for dairy entrepreneurs. It gives detailed explanation about material, finances, profits etc associated with different product mix which can be prepared in a small enterprise

31.2 Economic Role of Dairying

Dairying plays an important role in strengthening India’s rural economy. It has brought socio economic transformation. A symbiotic relationship exists between agriculture and dairy farming. The agricultural byproducts provide feed and fodder for the cattle whereas cattle provides necessary draught power for various agricultural operations apart from providing nutritional security and ready cash for milk producers from sale of surplus milk. India is the largest milk producing country in the world. About 70 million farmers rear a milch herd of about 105 million (58 million cows and 47 million buffaloes). They contribute 98 percent of milk produced in the country. More than 70 percent of milk producers in India are small marginal farmers. They possess low yielding animals.

Small holder dairy development being practiced in India has the potential to remove poverty. It can provide employment to the family, generate income on a daily basis and provide milk for home consumption. For the resource poor and landless owing a milch animal act as a boon. In India, the labour dependent on crop production has been reduced to 54 percent in 2000 from 74 percent in 1961 and that dependent on livestock and milk production increased from 2 percent in 1961 to 4.1 percent in 2000.

A study in the southern state of India has shown that rearing of dairy cattle by resource poor families, particularly women helped them earn an annual income ranging from Rs. 14,822 to 47, 820. Contribution of income from dairying was significant. Majority of families earned between 50-75 percent of their income from dairying and there was not a single family that earned income less than 25 percent from dairying.The characteristics of production activities preferred by women were studied. All the activities of dairy clearly fit their preferences. Also the dairy activities do not put any extra pressure on women and can be treated as part of the household chores. The studies have indicated that the money earned by women from sale of milk is used in managing the household. The income from milk helps good upkeep of family members as well as of milch animals. Dairying supplemented family nutrition as the first priority was given to family consumption and then the surplus milk was sold.

A nationwide study in India by the National Council of Applied Economic Research on ‘Impact Evaluation of Operation Flood’ in 1999 reported that dairy production, sale of milk alone accounted for the bulk of the contribution to the household income from livestock. Annual household cash income by sources in different land holding categories revealed by the NCAER study is shown in given table.

Table 31.1 Annual household cash income by various sources in different land holding categories

Category	Dairy (%)	Crop (%)	Others
Landless	53.08	0.00	46.92
Marginal	30.14	46.55	23.30
Small	29.17	53.75	16.58
Small – medium	26.25	58.98	14.76
Medium	25.33	62.77	11.91
Large	19.02	71.48	9.50

31.3 Case Study

31.3.1 Illustrative example for small scale dairy entrepreneur

To establish a dairy business on small scale (100 to 200 liters/day), some of the basic equipments like the Fat testing machine, Milk cans, Facility to boil the milk; Cream Separator, etc are required. In general, the production cost includes cost of raw materials, processing, fuel charges, interest on investment, depreciation/rent on buildings, marketing etc. Following is the illustrative example wherein the market price prevailing in August 2010 are considered. For a small household dairy entrepreneur handling 100 Kg of milk capacity per day, the following points may be considered to know the production cost.

31.3.1.1 Cost of land & building

For establishing a cottage type/house hold dairy business, a room of at least 15 feet x 15 feet may be required. The rent for the same (small space) may be assumed as Rs. 2000 per month.

31.3.1.2 Cost of equipment

Table 31.2 Cost of equipments

Name of the equipment	No.s	Cost (Rs.)
Multipurpose vat/Kettle of 100 liter capacity with diesel or Gas furnace chulah	1	40,000/-
Milk cans/Pails/ Other containers	5	7,000/-
Cream Separator of 165 lit. capacity	1	15,000/-
Hand cum electric Butter Churn	1	8,000/-
Scrapers & Sweet containers	1	3,000/-
Fat testing machine (hand operated)	1	3,000/-
Deep Freezer (500 liter)	1	25,000/-
Miscellaneous Fixed assets	--	24,000/-
Investment in Net Working capital		25,000/-
	Total Investment	1,50,000/-

31.3.1.3 Manufacturing cost (for 30 days)

Table 31.3 Manufacturing cost

Particulars		Cost (Rs)
Milk 100 Kgs. (6 % fat) per day Considering cost of Fat: 350 Rs/ Kg fat		63000/-
Labor charges (2 persons)		5,000/-
Fuel Charges		5000 to 10000 (Variable depending upon type of product to be prepared)
Electricity charges		2000/-
Rent		2000/-
Miscellaneous Expenses		4000/-
	TOTAL		81000 to 86000/-

31.3.1.4 Probable Sales

It is possible to produce different types of milk products. It is beneficial to prepare milk products as per the demand and season of the year to reduce spoilage loss and storage cost. Following table indicates probable profitability associated with different milk product mix options available to entrepreneur.

Table 31.4 Profitability associated with different milk products

Product combination	Monthly production	Selling Price per unit (Rs.)	Sales Revenue (Rs.)
Sweet Dahi	90 Kg	35	94500/-
Ghee	1.5 Kg	270	12150/-
			1,06,650/-
Sour dahi	90 Kg	25	67500/-
Ghee	5.8 Kg	270	46980/-
			114480/-
Maska	25 Kg	80	60000/-
Ghee	5.8 Kg	270	46980/-
			106980/-
Paneer	18 Kg	180	97200/-
Ghee	2 Kg	270	16200/-
			113400/-
Mava	23 Kg	150	103500/-
Ghee	2 Kg	270	15600/-
			119700/-
Peda/Burfi	25 kg	170	127500/-
Gulab Jamun	45 Kg	100	135000/-
Shrikhand	50 kg	85	127500/-
Ghee	3 Kg	270	24300/-
			151800/-

D. Probable Profit from Different product mix manufacturing possibilities per month

Table 31.5 Probable Profit from Different product mix manufacturing possibilities

Product Combination Number	Sale per month, Rs	Production cost per month, Rs	Net profit per month, Rs*****
01	1,06,650	81000	25650
02	114480	81000	33480
03	106980	81000	25980
04	113400	81000	32400
05	119700	86000*	33700
06	127500	91000**	36500
07	135000	96000***	39000
08	151800	107000****	44800

 

• Includes cost of sugar.
• Includes fuel cost and cost of sugar. Fuel cost increases due to heat desiccation and frying. (Rs 5000 as fuel cost and Rs 5000 as cost of sugar for 6 Kg sugar to be added)
• Includes fuel cost and cost of sugar. Fuel cost increases due to heat desiccation and frying. (Rs 5000 as fuel cost and Rs 10000 as cost of sugar for 12 Kg sugar to be added)
• Shrikhand preparation cost includes cost of sugar and flavouring agents.
• Net profit mentioned is for 100 liters of milk handled per day at initial level capacity. However there is full scope to increase the production capacity.

31.3.1.5(F) Financial feasibility
To evaluate the financial feasibility of the given project the following important points have been considered

* Total Capital cost of the project.(i.e long term funds required for the project)
* Calculation of Cost of Production.
* Calculation of Gross and Net working capital
* Statement of annual Income & expenditure and net surplus.
* Cash flow for the entire life of the project & checking the financial feasibility of the project using most popular criteria such as - NPV (Net present Value), IRR (Internal Rate of Return), Payback Period & Benefit cost ratio.

I Total Capital cost of the project.(i.e long term funds required for the project)
Refer to the data given in Table No.31.2
The total investment outlay of the project will be Rs. 1, 50,000. Out of which ,
Plant & machinery, equipment cost = Rs. 1, 25,000
& Investment in Net working capital = Rs. 25,000

Project life is assumed to be of 5 years
Plant & Machinery shall be depreciated by using the straight-line method. Assuming the scrap value of Plant & machinery at the end of 5 years as 12,500, the annual depreciation comes to

Annual Depreciation = Rs. (1,25,000 – 12,500)
5 years = Rs. 22,500 p.a

The requirement of working capital is likely to change over time. At the start of business there is an initial investment in working-capital. This level of working capital changes with the level of output of the firm. Working capital is not subject to depreciation hence the salvage value of working capital at the end of project is assumed to be the same as its book value (i.e. Rs 25,000)

Bank Loan

The entire outlay of the project Rs 1,50,000 will be financed from a bank, with condition of 20% margin money & 14% rate of interest for a loan period of 5 years.

This indicates -

Rs. 30,000 = Contribution to be made by the owner
Rs. 1,20,000 = Bank loan with rate of interest 14% p.a for 5 years

Equated Monthly Installment (EMI) has been calculated as follows -

Principal = Rs. 1,20,000
Interest = 14% × 1,20,000 × 5 years

= 84,000
Total amount to be repaid in 5 years = Rs, 2,04,000 /-
(EMI) Equated Monthly Installment = Rs. 2,04,000
12 × 5
= Rs. 3400 /-
Annual Installment = Rs. 3400 × 12
= Rs. 40,800 /-
II. Calculation of cost of production.
The cost of production has been calculated as the cost of processing/manufacturing products from 100 liters of milk per day. Refer to the data given in Table No.31.3

Table 31. 6

Manufacturing cost for 100 liters Milk per day.
a)	Cost of material Milk 100 kg. 6% fat Cost of fat @ Rs 350 /kg fat	Rs. 2100 per day
b)	Cost of labour Monthly salary for two workers is Rs. 5000	Rs. 166.66 per day
c)	Fuel consumption charges Range Rs. 5000 – Rs. 10,000 p.m Considering upper limit Rs. 10,000 p.m	Rs. 333.33 per day
d)	Electricity charges Rs. 2000 p.m	Rs. 66.66 per day
e)	Rent Rs. 2000 p.m	Rs. 66.66 per day
f)	Miscellaneous Rs. 4000 p.m expenses	Rs. 133.33 per day
	Total cost Total cost incurred in processing / manufacturing products from 100 Kg of milk per day	Rs. 2866.00 per day

 

III Calculation of Gross and Net working capital

Gross working capital is defined as the Total of current Assets and Net working capital is defined as current assets (CA) minus current liabilities (CL),

Assumptions

• No short term interest bearing loans or a cash credit facility from a bank has been availed.
• The Net working capital (CA - CL), represents the amount of working capital to be supported by the long term funds. The investment in net working capital has been made in the initial outlay (capital cost) of the project itself.

Table 31. 7

A	Current Assets
a)	Inventory · Stock of milk for 1 day · Work-in-process for 1 day · Finished goods stock held for 3 days Total inventory	Rs. 2100 Rs. 2866 Rs. 2866 × 3 Rs.13,564
b)	Debtors · Debtor collection period 1 day (i.e credit extended to customers is one day )	Rs. 2866
c)	Cash Balance · Assumed amount	Rs. 18570
	Total Current Assets	Rs. 35000
B	Current liabilities
	· Deferred wages – one month	Rs. 5000
	· Deferred Rent – one month	Rs. 2000
	· Deferred Electricity charges – one month	Rs. 2000
	· Deferred payment of miscellaneous expenses– one month	Rs. 1000
	Total current liabilities	Rs. 10,000
	NET WORKING CAPITAL (To be supported by long term funds) Current assets – current liabilities=(A - B)	Rs. (35,000 – 10,000) Rs. 25,000

Note on working capital

The level of Gross working capital (Current Assets) is affected by several factors such as seasonal fluctuations, demand of products, certainty in supply of milk, quality of debtors, availability of credit from the supplier etc. Hence, the working capital level changes throughout the life of the project. A prudent entrepreneur should try to minimize his investment in working capital, but at same time ensure that there are no production stoppages due to lack of materials, there is no loss of business due to non granting of credit to customers etc. In case of large cash balances lying idle in bank, such amounts should be invested in short term bank fixed deposits or any other suitable short term financial security.

IV. Statement of annual income & expenditure and net surplus.

Table 31. 8

	Calculation of Income & expenditure :-
A.	Annual Income from Sales Revenue. The sales revenue has been taken as the average of the 8 options given in table no. 5	Rs. 1,21,938 × 12 Rs. 14,63,256
B.	Annual Cost of Processing /Manufacturing products from 100 liters of Milk per day. This cost has been taken as an average of the 8 options given in table no.5	Rs. 88,000 × 12 Rs. 10,56,000
C	Gross Profit (Before Depreciation, Interest & tax) = A – B	Rs. 4,07,256
	Less : Annual Depreciation of Plant & machinery	Rs. 22,500
D	Operating Profit (Profit before Interest & Tax)	Rs. 3,84,756
E	Appropriations from the Profit
F	Profit	Rs. 3,84,756
G	Annual cash outflow due to Repayment of Loan (principal & Interest)	Rs. 40,800
H	Net Surplus with the owner (before tax)= F-G	Rs. 3,43,956

Note:

1. The owner pays annually Rs. 40,800 to the bank as a repayment of his loan. At this juncture the break up of Rs. 40,800 into Principal portion and interest portion is not necessary.(Though it can be done if required).

2. The Net surplus before tax has been given because the Net profit after tax depends upon the tax slabs and tax planning of individual owners.

V Cash flow for the entire life of the project & checking the financial feasibility of the project.

Calculation of cash flows and Project profitability

Table 31. 9

Particulars/ Year	0	1	2	3	4	5
Capital equipment	-125,000	-	-	-	-	-
Net working capital	-25,000	-	-	-	-	-
Sales Revenues (Average of all 8 option given in table No5 .)	-	1,463,265	1,463,265	1,463,265	1,463,265	1,463,265
Cost (Average of all 8 option Given in table No 5.) (excluding Depreciation & Interest)	-	1,056,000	1,056,000	1,056,000	1,056,000	1,056,000
Depreciation	-	22,500	22,500	22,500	22,500	22,500
Profit before tax [3-4-5]	-	384,765	384,765	384,765	384,765	384,765
Assumed Tax rate @ 20%	-	76,953	76,953	76,953	76,953	76,953
Profit after tax (6 – 7)	-	307,812	307,812	307,812	307,812	307,812
Net salvage value of fixed assets	-	-	-	-	-	12,500
Net Recovery of working capital	-	-	-	-	-	25,000
Initial Outlay (Initial cash outflow) (1+ 2)	-150,000	-	-	-	-	-
Operating cash flow (8+5)	-	330,312	330,312	330,312	330,312	330,312
Terminal cash flow (9+10)	-	-	-	-	-	37,500
Net cash flow	-150,000	330,312	330,312	330,312	330,312	367,812

The Net cash flows for the entire life of the given project can be summarized as follows

Table 31. 10

	Year	0	1	2	3	4	5
a	Net cash flow	-150,000	330,312	330,312	330,312	330,312	367,812
b	Discount factor @ 15%	-	0.86956	0.75614	0.65751	0.57175	0.497177
c	Discounted cash flows (a*b)	-150,000	287,228	249,763	217,186	188,857	182,868
d	Total Present Value of benefits =sum of discounted cash flows from year 1 to 5.	1,125,901
e	Total investment in 0th year	150,000
	Net Present Value (d - e)	975,901	The project is acceptable since its NPV is positive.

Calculation of NPV at higher discounting factors

Table 31.11

Discount factors	Total PV of benefits	Total Investment	NPV	Benefit cost ratio= PV/investment
15%	1125901	150000	975901	7.506008
20%	1002905	150000	852905	6.686037
30%	814598	150000	664598	5.430652
50%	578567	150000	428567	3.85711

31.4 IRR (INTERNAL RATE OF RETURN)

From the above table it is clear that the IRR of the project ( i.e the discount factor for which the value of NPV becomes zero) is much higher than 50%.

31.4.1 Payback period

It is the time period in which the initial investment of the project is fully recovered. Clearly, by looking at the net cash flows it can be seen that the project has a payback period of less than one year.