REO and RoI – What’s the difference?

20-01-2009 | |
John Gadd Topic: Pig Management

I know – boring old economics! But please read on, as so many of you get the two mixed up, including dare I say it – several economists! REO (Return on Extra Outlay) is a much more useful term than RoI (Return on Investment). One sees RoI being used constantly – usually in the wrong way – when REO would be far more appropriate.

Why? Because REO is a very useful term to compare the use of relatively small sums of working capital with one another – such as feed additives, veterinary medicines, biosecurity products, AI practices, feed hoppers and so on. There are legions of products clamouring for the pig producer’s hard-earned capital in the day to day running of a pig business. What REO does is to compare not only one product within each category with each other – various in-feed growth enhancers on offer, for example, but it can also be used to compare products or management ideas right across different categories.

For example, ‘If I spend the same sum on a growth enhancer as, for example, on an upgrade to a superior disinfectant, which of these two options – from the published claims or research results – is likely to get me the better return per year/per pig/ per pig place?’ What REO does is to sort out which options are best value for money in a simple and easily-calculated way, using day-to-day working capital in the most cost-effective manner.

Return on Investment is quite different. ‘Investment’ here refers to relatively large sums of fixed capital such as in buying another farm or incorporating a new section into an existing one (gilt pool, AI dept., updating manure disposal, putting in the latest ventilation system etc.). Big deals in other words, needing far more fiscal support than the much smaller REO assessments. Things like funding costs, amortisation length, tax offsetting, leasing options, contract hiring etc. These complexities are just not needed in REO situations.

AIV and REO together
AIV (Annual Investment Value) works hand in hand with REO like this. Supposing an REO exercise shows a much more favourable advantage to one product than another. Well and good – but is it?© One of the criteria a bank manager uses when deciding which is the best applicant for his funds is to rank them according to how much the loan will be turned over, usually across one year. The more feasible this looks the better – and the applicant jumps ahead in the queue. This is especially valuable when credit is short, as of now.

©In our case take an in-feed growth enhancer. Used from weaning to slaughter, the REO may be a very satisfactory 10 to 1 (the outlay being recouped tenfold every 22 weeks or 2.4 times a year). This is an AIV of REO 10 x 2.4 = 24. A competitive product in a creep feed however, has a seemingly modest REO of 4 to 1.
A no brainer? But wait a minute; the creep feed is used per sow for about 6 weeks at most, or 8.7 times a year. So the AIV is REO 4 x 8.7 = 34.8.© The same working capital makes much better use of the money even if the REO looks at first glance to be considerably poorer.

Always check on an REO calculation by following up with an AIV. Or you may choose (or be sold) the wrong product. I see this happening frequently.

Economics are not boring after all – are they! See what I mean?

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