Sheep on Shares
EC-1168, April 1999
Erin Brown, Dan Nudell, Harlan Hughes, Tim Faller
Hettinger Research Extension Center and NDSU Extension
Service
Introduction
Determining What Is An Equitable
Leasing Agreement
Include All Income From Sheep Flock In The
Agreement
Projecting The Full Costs of Production
An Example Equitable Share Agreement
Cull Ewe Income Versus Cost Of Replacement
Females
An Alternative Leasing Agreement
Final Comments
Computerized Worksheets
The sheep industry is undergoing major
fundamental structural changes. The American Sheep Industry
Association predicts that expanded sheep production will move
into the farm belt of the upper great plains. As this happens,
the potential exists for new producers to enter the business.
One of the entry methods may be to use leased or rented ewes.
Investors are expressing interest in owning sheep, and working
farmers and ranchers are looking for alternative ways to finance
sheep flock expansion. A sheep lease arrangement may provide a
vehicle for a retiring sheep producers to help the next
generation get started and also provide a method for deferring
capital gains on the flock.
One way for an investor to capture some of the economic
profits from sheep production is to own the sheep and lease them
to a working farmer or rancher. In turn, the working farmer or
rancher provides the labor, feed, and all other inputs needed to
operate the sheep flock but does not need to provide investment
capital for sheep ownership.
A leasing or sharing arrangement allows these two business
people to share the production costs and, in turn, share the
sheep income. A question that quickly surfaces, however, is that
of what would be an equitable sheep leasing agreement.
This circular will show one way to determine an equitable
sheep leasing agreement.
Determining What Is An Equitable
Leasing Agreement
The theoretical procedure for determining an equitable sheep
share agreement is really quite simple. An equitable agreement is
one in which the two parties share business income in the same
proportion that they share production costs. If the ewe owner
provides 25 percent of the production costs, then the ewe owner
should receive 25 percent of the total income and the
participating rancher should receive 75 percent of all income.
Expenses can be shared in many different ways. In some cases
the ewe owner provides the ewes, the rams, and sometimes even the
summer pasture. Typically, however, the owner of the ewes
provides only the ewes and the replacement females, and the
participating rancher provides the rest of the resources. Each
equitably shared arrangement should be tailored to the two
participants' unique resource contributions.
Include All Income From Sheep Flock In The
Agreement
Although in a typical lease the equity question relates mainly
to the sharing of the lamb crop, it is important to note that
"all" the income from the flock should be accounted
for. A sheep enterprise can generate income from four sources:
lamb sales, cull ewe sales, cull ram sales, and wool. An
equitable sharing agreement has to ensure that all potential
income sources are taken into account. Each party needs to
clearly understand the total income potential of the flock.
Projecting The Full Costs of Production
An equitable sheep share agreement should be based around the
projected full costs of production. Full costs should include all
resources employed in the sheep enterprise, including the direct
costs, the opportunity costs for the working rancher's labor and
management, and the equity capital of both parties. Ewe
depreciation should be included in place of replacement ewe costs
(more on this later).
An example of a cost budget for a sheep flock is presented in
Table 1. The projected cost of feeding this North Dakota sheep
flock from weaning the previous year until weaning the current
lamb crop is $5,328.30 total feed cost, or $53.28 per ewe. Add
vet and medicine at $4.50 per ewe, utilities at $3.00 per ewe,
power and fuel at $0.95 per ewe, marketing at $5.44 per ewe,
bedding at $.30 per ewe, shearing at $1.75 per ewe, and
miscellaneous supplies at $1.00 per ewe to get a projected
non-feed direct cost of $16.94 per ewe, or $1694 for the total
flock. An operating capital interest cost of $280.89 is assigned
to the flock to cover the cost of capital for operating expenses.
This example enterprise assumed that variable costs are used
throughout the year, so on average the use is one-half of the
total. The opportunity cost of this capital was assumed to be 8
percent. After accounting for asset depreciation, equipment and
building repairs, and insurance, the total projected direct cost
of operating this flock comes to $9220.69, or $92.21 per ewe.
Table 1. Sample projected cost budget for a 100-ewe flock (lambs
fed to 130 lbs).
---------------------------------------------------------------
Total
Units Price Costs
---------------------------------------------------------------
Feed Costs -
Hay 52.00 tons $45.00 $2,340.00
Pasture 89.00 AUMs $12.00 $1,068.00
Grain 977.00 bu $1.90 $1,856.30
Protein supplement 0.00 lbs $0.00 $0.00
Stubble 37.00 AUMs $0.00 $0.00
Commercial feed total flock cost $64.00
-----------
Total feed cost for enterprise $5,328.30
Annual feed cost per ewe $53.28
---------------------------------------------------------------
Livestock Costs -
Bedding per ton $15.00 $30.00
Marketing charges
for flock per ewe $5.44 $544.00
Vet and medicine per ewe $4.50 $450.00
Power and fuel per ewe $0.95 $95.00
Utilities and
general farm
expenses per ewe $3.00 $300.00
Supplies per ewe $1.00 $100.00
Shearing per ewe $1.75 $175.00
-----------
Annual livestock costs per flock $1,694.00
Annual livestock costs per ewe $16.94
Operating capital interest* $280.89
Total variable costs per ewe $73.03
---------------------------------------------------------------
Fixed Costs (depreciation, repairs, insurance) -
Buildings (depreciation, repairs, insurance) 7% $350.00
Equipment (depreciation, repairs, insurance) 13% $260.00
Ewes (depreciation and insurance) $1,100.00
Rams (depreciation and insurance) $207.50
-----------
Total fixed costs $1,917.50
Total fixed costs per ewe $19.18
---------------------------------------------------------------
Total Costs (excluding labor, management, equity capital) -
Total direct costs per ewe $92.21
---------------------------------------------------------------
* Operating capital interest was computed by multiplying
one-half of the variable costs (feed and livestock) by
the economic or long-term interest rate. This sample
projection used a rate of 8%.
The second step in setting up an equitable sheep share agreement
is to calculate the opportunity costs of selected resources
provided by both parties (see Table 2). In this example flock,
the three hours of labor required per ewe on an annual basis was
priced at $8 per hour, management charge was calculated at 5
percent of gross income, and the charge for equity capital was
valued at 8 percent of fair market value of assets. When the
labor cost of $2400, management charge of $655.13, and equity
capital charge of $1420 are added in, the full-cost budget comes
to $13695.82, or $136.96 per ewe.
Table 2. Opportunity costs for selected resources.
-------------------------------------------------------------
Labor charge 3.00 hours @ $8.00 $2,400.00
-------------------------------------------------------------
Management charge 5% of gross $655.13
-------------------------------------------------------------
Capital investment 8% of investment Value
Ewes $10,000.00 $800.00
Ram(s) $750.00 $60.00
Buildings $5,000.00 $400.00
-----------
Total equity capital interest cost $1,420.00
Management charge $655.13
Labor charge $2,400.00
Total direct cost $9,220.69
-------------------------------------------------------------
Full cost of production $13,695.82
-------------------------------------------------------------
Full cost of production per ewe $136.96
-------------------------------------------------------------
Unit full costs of production 1.74 cwts/ewe $0.79 per lb.
-------------------------------------------------------------
Table 3 presents a detailed description of the example herd. This
flock had 100 females (80 mature ewes plus 20 replacement
females) exposed to rams the fall before. These ewes had a
conception rate of 95 percent, so 95 were assumed pregnant. Since
no pregnancy checking was done, all 100 ewes were wintered. The
100 wintered ewes produced 143 live lambs. Eighteen lambs died
and five were sold as bums before weaning so that 120 live lambs
were weaned. This calculates to a 120 percent lamb crop (120/100)
based on live lambs weaned per females exposed. This 120 percent
lamb crop was calculated according to the National Sheep-SPA
Guidelines.
Table 3. Description of example sheep flock.
-----------------------------------------------------------------
100 Head Spring Lambling Ewe Flock
-----------------------------------------------------------------
Expected replacement 20 head ewe death rate 5%
-----------------------------------------------------------------
Lamb weaning rate 90 days ewe culling rate 15%
-----------------------------------------------------------------
Feed included for 100 ewes ewe conception rate 95%
percent lamb crop 132%
-----------------------------------------------------------------
Lambs fed to 130 lbs 120 head lamb death rate 12.5%
replacement females purchased
-----------------------------------------------------------------
Number of rams 3 head
-----------------------------------------------------------------
Table 4 presents the projected total income for the example sheep
flock. The 120 lambs were split evenly between wethers and ewe
lambs. Fifteen ewes and one of the three rams were culled this
year. These lambs were sold at 130 pounds for $0.75 per pound,
producing income of $11,700. In addition 5 bum lambs were sold
for $10 each bringing lamb income to $11,750. The cull ewes
brought $787.50 and the cull ram $50. Wool income was $515. The
total income for this flock was $13102.50, or $131.03 per ewe.
Table 4. Gross revenue for 100-ewe flock.
-------------------------------------------------------------
Economic
Cash Flow Receipts Output
-------------------------------------------------------------
$11,700.00 120 lambs 15600 lbs $0.75/lb = $11,700.00
$787.50 15 cull ewes 2250 lbs $0.35/lb = $787.50
$50.00 1 ram $50.00/hd = $50.00
$50.00 5 bum lambs $10.00/hd = $50.00
$515.00 shorn wool 1030 lbs $0.50/lb = $515.00
------------
$13,102.50 gross income per flock $13,102.50
$131.03 gross income per ewe $131.03
-------------------------------------------------------------
* Cash flow income does not need to equal economic income.
It will be different if there is an inventory change
and/or capital gains income is received from the sale of
cull breeding animals.
The third step in setting up an equitable sheep share agreement
is to allocate each resource cost to the party that will pay that
particular production cost. Each member of the agreement can
contribute any combination of resources as long as each party
agrees on who is responsible for each and every production cost.
An Example Equitable Share Agreement
Let's evaluate a typical sheep lease situation where the
investor furnishes the ewes, the rams and the replacement
females. The participating rancher provides the feed, labor and
management. Table 1 suggests that the cost (excluding labor,
management and equity) of running this study flock is $9220.69,
or $92.21 per ewe. Table 2 shows the projected full cost of
operating this sheep flock, which totals $13,695.82, or $136.96
per ewe.
Once the total costs are determined, the next step is to
allocate each and every cost to be shared between the two
participants. This cost allocation is best done by adding in two
more columns on the cost budget one for the ewe owner and one for
the working rancher (see Table 5).
Table 5. Sample projected full-cost budget for a 100-ewe flock
(lambs fed to 130 lbs.).
----------------------------------------------------------------------
Total % To Owner Working
Units Price Costs Owner of Ewes Rancher
-----------------------------------------------------------------------
Feed Costs -
Hay 52.00 tons $45.00 $2,340.00 0% $0.00 $2,340.00
Pasture 89.00 AUMs $12.00 $1,068.00 0% $0.00 $1,068.00
Grain 977.00 bu $1.90 $1,856.30 0% $0.00 $1,856.30
Protein
supplement 0.00 lbs $0.00 $0.00 0% $0.00 $0.00
Stubble 37.00 AUMs $0.00 $0.00 0% $0.00 $0.00
Commercial flock
feed total use $0.00 $64.00 0% $0.00 $64.00
----------- -------------------
Total feed cost for enterprise $5,328.30 $0.00 $5,328.30
Annual feed cost per ewe $53.28
-----------------------------------------------------------------------
Livestock Costs -
Bedding per ton $15.00 $30.00 0% $0.00 $30.00
Marketing per ewe $5.44 $544.00 0% $0.00 $544.00
Vet and medicine $4.50 $450.00 0% $0.00 $450.00
Power and fuel $0.95 $95.00 0% $0.00 $95.00
Utilities and general
farm expenses $3.00 $300.00 0% $0.00 $300.00
Supplies $1.00 $100.00 0% $0.00 $100.00
Shearing $1.75 $175.00 0% $0.00 $175.00
----------- -------------------
Annual livestock costs per flock $1,694.00 $0.00 $1,694.00
Annual livestock
costs per ewe $16.94
Operating capital interest* $280.89 0% $0.00 $280.89
Total variable costs $7,303.19 $0.00 $7,303.19
Total variable
costs per ewe $73.03
-----------------------------------------------------------------------
Fixed Costs (depreciation, repairs, insurance) -
Buildings (depreciation,
repairs, insurance) $350.00 0% $0.00 $350.00
Equipment (depreciation,
repairs, insurance) $260.00 0% $0.00 $260.00
Ewes (depreciation
and insurance)** $1,100.00 100% $1,100.00 $0.00
Rams (depreciation
and insurance)** $252.50 100% $252.50 $0.00
----------- ---------------------
Total fixed costs $1,917.50 $1,352.50 $610.00
Total fixed costs per ewe $19.18
-----------------------------------------------------------------------
Total Costs(excluding
labor, management and
equity capital) $9,220.69 $1,352.50 $7,913.19
Total costs per ewe $92.21
-----------------------------------------------------------------------
* Operating capital interest was computed by multiplying
one-half of the variable costs (feed and livestock) by the
economic or long-term interest rate. This sample projection
used a rate of ????????
** Insurance estimated at 1% of total value and depreciation at
$10/ewe/year.
*** Insurance estimated at 1% of total value and depreciation at
$10/ram/year.
-----------------------------------------------------------------------
Labor charge 3.00 hours @ $8.00 $2,400.00 0% $0.00 $2,400.00
Management charge 5% of gross $655.13 0% $0.00 $655.13
Capital investment 8%
Ewes $10,000.00 $800.00 100% 800.00 $0.00
Ram(s) $750.00 $60.00 100% $60.00 $0.00
Buildings $5,000.00 $400.00 0% $0.00 $400.00
Equipment $2,000.00 $160.00 0% $0.00 $160.00
----------- ---------------------
Total equity capital $1,420.00 $860.00 $560.00
interest cost
-----------------------------------------------------------------------
Full cost of production $13,695.82 $2,212.50 $11,528.32
Full cost of
production per ewe $136.96
Unit full costs
of production 1.74 cwts/ewe $0.79 per lb. $0.13 $0.66
Percent contribution 16% 84%
-----------------------------------------------------------------------
Each resource cost is then allocated to the party that is going
to pay that cost. When labor, management, and capital costs are
added, and all cost items are allocated item by item to the ewe
owner and participating rancher, each participants' full cost can
be figured. Participants' cost contribution percentages are equal
to their own total costs divided by the overall total cost column
(see Table 5).
The owner of the sheep flock represented in Table 5 is
projected to contribute 15 percent of the full cost and the
participating rancher is projected to contribute 85 percent of
the full cost. This suggests that an equitable share agreement
would be one where the ewe owner receives 15 percent of the lamb
and wool income, plus all the cull ewe income and all the cull
ram income. The participating rancher should receive 85 percent
of the lamb and wool income.
Table 6 indicates that sharing all lamb and wool income in
this herd in this 16-84 proportion, the owner of the ewes is
projected to receive $28.19 per ewe $18.90 from the sale of lambs
and wool plus $8.37 cull sales income. The working rancher is
projected to receive $102.84 per ewe from lamb and wool sales.
Table 6. 16-84 equitable share agreement.
-----------------------------------------------------------------------
Total % To Owner Working
Flock Owner of Ewes Rancher
-----------------------------------------------------------------------
Economic Income/Ewe from 100 Ewes -
1.20 head lambs 130 lbs $0.75/lb $117.00 16% $18.90 $98.10
0.15 cull ewes 150 lbs $0.35/lb $7.87 100% $7.87 $0.00
0.01 cull ram 1 head $50.00/hd $0.50 100% $0.50 $0.00
0.05 bum ram 5 head $10.00/hd $0.50 16% $0.08 $0.42
0.01 shorn wool 1030 lbs $0.50/lb $5.15 16% $0.83 $4.32
-----------------------------------------------------------------------
$131.03 $28.19 $102.84
Gross economic income for flock $13,102.50 $2,818.86 $10,283.64
Share 22% 78%
-----------------------------------------------------------------------
Replacement ewes purchased to maintain flock $2,000.00
Owners return on investment $818.86
Owners percent return on original investment 7.62%
-----------------------------------------------------------------------
In terms of total income, the ewe owner gets 22 percent of all
income and the working rancher gets 78 percent, even though the
lamb and wool crop is to be shared 16-84. The example equitable
share calculations shown in Table 1 through 6 indicate an
equitable share that is different than the common share
arrangements that range from 25-75 to 50-50. Cull ewe, cull open
replacement ewes and cull ram income goes to the party that
provides the investment capital.
Cull Ewe Income Versus Cost Of Replacement
Females
Lamb crop sales may account for only 70 to 80 percent of the
total income per ewe in a ewe flock. The remaining 20 to 30
percent of the ewe flock's income typically comes from cull
animals and wool. Cull ewes account for the biggest share of the
cull animal income. Managers who buy replacements will have more
lambs to sell, so cull ewe sales will be a smaller part of gross
sales. Regardless of the size of cull ewe income, it should be
shared in the same proportion as the costs of replacement females
are shared.
In this lease arrangement the ewe owner provides replacement
females. The ranch operator should not receive any cull ewe
income if he/she does not own the ewes nor has contributed any of
the costs of raising or placing the ewe into the breeding herd.
The ewe owner should receive all the cull ewe income.
Theoretically it is the undepreciated portion of the original
capital investment. The depreciation costs are included in the
ewe owner's contribution of the full cost production expenses.
Yearly depreciation can be calculated as follows:
(purchase cost - projected salvage value)
Depreciation = -------------------------------------------
projected years ewe is in the flock
where salvage value is the projected value of cull ewes at the
time that they are culled from the leased herd. Cull animal
income goes to the ewe owner. The total price risk associated
with the value of the ewe when culled is absorbed by the ewe
owner.
Depreciation calculated with a zero salvage value would be
appropriate if both parties share cull income. This can be done
by calculating depreciation with a zero salvage value and letting
depreciation account for the total original investment cost of
the ewe. This way a larger portion of the original ewe investment
is repaid to the ewe owner each year the ewe is in the flock. In
this type of an arrangement, cull ewe price risk is shared by
both parties. Depreciation, in this case, should be calculated
as:
(purchase cost - projected salvage value)
Depreciation = -------------------------------------------
projected years ewe is in the flock
When depreciation is calculated this way, all cull animal
income is shared in proportion to expense contributions. Very few
leasing arrangements, use this second approach.
A third leasing arrangement is where the replacement females
are raised inside the leased ewe flock, resulting in the cost of
replacement ewes being shared by both parties. Depreciation
should go back to the previous method that includes a salvage
value. The cull animal income, in this case, should be shared by
the parties in proportion to their total flock expense
contributions. Our experience to date has been that this leasing
arrangement is messy at best, and frequently leads to inequitable
leasing arrangements because ownership of the flock is changing
each year.
We think a better alternative, if replacements are to come
from the flock, would be to have the ewe owner purchase the
replacements at market lamb value at the time of sale. This
provides the rancher some level of control on the replacements in
the leased flock and saves him the marketing expense for the sold
replacements. The ewe owner also gains more control of the
replacements he buys and may save any premiums that replacement
females bring in the market.
In summary, we recommend that the replacement females be
handled outside of the leased enterprise. We recommend the ewe
owner provide all replacement ewes. This is the most common
arrangement and seems to be the easiest way to ensure
equitability.
An alternative to the lease where both parties share the
income is one where the ewes are leased for a set cash payment
each year. In this arrangement the rancher would pay the ewe
owner a fixed amount each year for the use of the ewe. From the
owner's perspective, this payment would need to cover the
depreciation of the ewes, the loss of animals, and a return to
the ewe for the investment. The party leasing the ewes will not
want to pay more rent than the income from the ewe's lamb and
wool production less all costs of production including a value
for labor and management.
A cash lease has advantages and disadvantages. The working
rancher absorbs all the price and production risk associated with
the year's production. If prices are lower or if environmental
factors affect the total production of the leased ewes, the
rancher is still obligated to make the same payment to the
resource owner. On the other hand, because of the extra risk
assumed, any extra income that occurs due to market prices or the
working rancher's efforts and skills accrues to the rancher.
A cash lease agreement may also serve to attract investor
income to the sheep industry since potential investors may be
more comfortable with a non-volatile return to their investment.
They may be willing to provide funds at a lower cost due to the
reduction in the risk they face as investors.
Two final cautions to people entering into a sheep share
agreement: first, agreements should be in writing and the written
contract should clearly identify all the specifics agreed upon.
Participants are advised to account for all production costs,
death losses and exactly how the business agreement will be
terminated. It is much easier to work out the share
agreement details before the agreement is signed than to work out
an agreement after an emergency or a business disagreement
occurs.
It should also be pointed out that two people can enter into
any legal agreement which both parties agree to, even if it is
not equitable. The important thing to remember is that the both
parties should agree on the terms of the business agreement and
that the details of the agreement are in writing.
The worksheets used in this bulletin are available as a
computer program that you can use on your home personal computer.
The program can be downloaded free from the web address:
http://www.ag.ndsu.nodak.edu/hettinge/shares/sosinstall.exe
EC-1168, April 1999
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