Presentation on theme: "Improving Profitability…… Why Farmers Need Farm Financial Management… Craig Chase, Field Specialist Farm & Ag Business Management."— Presentation transcript:
Improving Profitability…… Why Farmers Need Farm Financial Management… Craig Chase, Field Specialist Farm & Ag Business Management
Plan for today Two ways to improve profitability –Increase profitability per unit (or margin) while selling the same number of units. –Increase the number of units sold while keeping the same profitability per unit.
So what is margin? Margin is the difference between what you sold your product for and what the cost of producing and marketing that product was. To get a better understanding of margins we need to keep enterprise records.
Enterprise Budget An enterprise budget is an estimate of costs and returns to produce a product. For producers who grow a large number of different products. –Develop budgets for those products that contribute the most to your business goals. –Think of the 80/20 rule – for most businesses 80% of their profits (not revenue) are provided by 20% of their products.
Example of 80/20 You sell 5,000 chickens for $15.00 per chicken for a total of $75,000 in revenue. You also produce vegetables for a CSA; 60 shares at $350 per share for a total of $21,000 in revenue. Poultry is approximately 78% of your revenue.
Example of 80/20 Your net profit margin for chickens is $2 per head; $10,000. Your net profit margin for vegetables is $7,000. Poultry is approximately 59% of your net profit margin. As an enterprise, poultry has a net profit margin of 13%.
Example of 80/20 How would you treat the vegetable enterprise (as a secondary or primary enterprise)? What should you do with the poultry enterprise?
Enterprise Budget You can develop enterprise budgets for each major part of your business. –Example, CSA with poultry/livestock. Complete a CSA and livestock budget. –CSA with multiple seasons and use of high tunnels/greenhouses. Complete an enterprise budget for each season (spring, summer, fall) or production system (open ground, high tunnel, greenhouse). The process is the same for all scale of farming operations.
Profit Margin Analysis Your goal was to have a profit margin of 25%; or $0.25 out of every $1.00 of sales to stay in your business. Profit margin is what is left over to pay for your general farm overhead, family living expenses, savings, and farm growth.
Profit Margin Analysis You determine your profit margin analysis for each of your six major crops and put them in a table (that follows)…these are the six major crops that contribute 80% or more of your whole-farm profit margins.
Three (half) of your crops have a profit margin below your goal of 25%; potatoes, snow peas, and specialty green beans. –What do you do to increase their profit margins? Three (half) of your crops have a profit margin above your goal of 25%; greens, carrots, and heirloom tomatoes. –Do you analyze these as well or are you happy with the numbers? Profit Margin Analysis
Remember…. There are two ways to improve profitability…one of them is to increase your profit margin per unit produced. So you can either reduce your costs to produce and market your product or increase your price. Let’s first look at reducing your costs…
Reducing Cost – Enterprise Budget Use the budgets to calculate break- even prices and yields. –For example, cost per lb. of beans sold was $2.40 ($288/120 lbs). –Compare this number to other producers or published budgets to determine where costs are different and why.
Reducing Cost – Enterprise Budget A second reason – track key costs. –Green bean example, $180 (or 82%) of the total production cost is labor. Most of the labor is weeding and harvesting. –Question - can labor be lowered without reducing yields (i.e., can labor be more efficient)? –Crop inputs is a small percentage (10%) of total production costs, a 10% reduction in costs won’t affect total production costs significantly. Don’t spend time on small items…
Partial Budget – Another Tool A partial budget allows you to analyze a portion of your farm to determine if minor adjustments should be made. For example, should you: –Purchase transplants or grow from seed… –Custom hire or purchase machinery –Change marketing outlets
Partial Budget Partial budgets allows you to compare two alternatives side-by-side. The analysis tells you one of the alternatives is comparatively better than the other.
Partial Budget Components There are seven components to a partial budget: increased revenue, reduced cost, reduced revenue, increased cost, total positive effects, total negative effects, and net change.
Partial Budget Example Purchase 1000 transplants rather than growing from seed Positive EffectsNegative Effects Increases in revenue (1)Decreases in revenue (3) Decreases in cost (2)Increases in cost (4) Labor developing transplants $100Transplants ($.25 ea) $250 Crop inputs (soil mix, seed, etc.) 50 Total decrease in costs $150Total increase in costs $250 Total positive effects (5) $150Total negative effects (6) $250 Net change (7) -$100(Doesn’t make sense to buy transplants)
Partial Budget Example Analyze the purchase of a new 1-row potato harvester ($2,000, 7-yr life) Positive EffectsNegative Effects Increases in revenue (1)Decreases in revenue (3) Decreases in cost (2)Increases in cost (4) Labor (50 hrs) $500Labor (1 hrs) $ 10 Capital recovery cost 180 Taxes, housing, insurance (1%) 20 Repairs and maintenance (2%) 40 Total decrease in costs $500Total increase in costs $250 Total positive effects (5) $500Total negative effects (6) $250 Net change (7) $250 (per half acre) – makes sense to purchase
Partial Budget Example Change Marketing Outlet from Farmers’ Market to Institutional Market Positive EffectsNegative Effects Increases in revenue (1)Decreases in revenue (3) Institutional market sales $3,600Farmers’ market sales $4,500 Decreases in cost (2)Increases in cost (4) Farmers’ market labor costs $1,200Institutional market labor costs $600 Farmers’ mkt. supply, trans. costs 400Inst’l mkt. supply, trans. cost 100 Total decrease in costs $1,600Total increase in costs $700 Total positive effects (5) $5,200Total negative effects (6) $5,200 Net change (7) $0Toss-up – what are the non-economic factors?
Pricing The second way of increasing profit margin per unit sold is increasing the price of the product. For an individual product, what does it cost me to produce and market that product? If snow peas cost me $3.06 per lb. to produce and market, what should my price be?
Pricing So if your margin goal is 25% and your break-even cost is $3.06 per lb., your sales price would need to be $4.08 per lb. (3.06/.75; 25% of $4.08). Will your consumers and competition allow this price? If not, what price will they allow and what is your profit margin at that price? If you can’t get to where you want, what do you do?
Pricing Same process regardless of what you are producing… Example – CSA share cost you $240 per share to produce and market, price it at $320 ($240/.75). Chickens cost you $2 per lb. to produce and market, price at $2.67 per lb. ($2/.75).
Yes or No to Change - Enterprises Production change – key question: can you either increase yields without increasing costs or decrease costs while maintaining yields? Product mix – compare products based on your most limiting factor. If labor, determine which products return the most to you per hour. The ranking will likely be different on a per hour basis (e.g. green beans).
Yes or No to Change- Enterprises Pricing – you need to know your costs or otherwise you are shooting in the dark. Add a desired profit margin to your total cost of producing and marketing your product(s). Compare that price to customers’ willingness and competition. Market outlet – compare outlets that are available to you. Don’t focus on selling price (gross revenue), focus on net margins.
Yes or No to Change - Enterprises Purchase new equipment – the main reason to purchase equipment is to save labor. Compare the total cost of the new (used) piece of equipment to the labor savings.
Increasing Profit by Increasing Yields Second way of increasing profits… increasing the number of units sold without increasing the cost per unit. Can use partial budgets or enterprise budgets to note production level changes and determine if profit margins are increasing or decreasing.
Increasing Profit by Increasing Production Most production changes made will lead to an increase in total costs. So make your decision based on whether your profit margin per unit stays the same or improves. –For example you look at adding another 500 chickens for next year. As long as the profit margin per bird does not go down, then it would make sense to increase production.
Looking Beyond a Single Enterprise You should analyze profit margins for each of your major enterprises and if they fit into the 80/20 rule should all be equal to or higher than your profit margin goal. But what about the non-major enterprises? To keep track of all your non-major enterprises you need to calculate your whole-farm profit margin and make sure you do not go below your overall profit goal.
Whole-farm Profit Margins Whole-farm profitability can be illustrated by the income statement. You can use Quicken, QuickBooks, or other program to develop a qualified income statement. Remember that some programs Profit and Loss or Income Statements are not really Income Statements. You will probably need to make adjustments.
Income Statement; Yr ending 12/31/2011 Sale of products$140,000 Car and truck, gas and oil 13,200 Depreciation, repairs and maintenance 18,000 Crop or livestock inputs 19,800 Insurance, interest, repairs, taxes 18,400 Labor 24,600 Supplies 8,000 Utilities 8,000 Total Expenses$110,000 Net Income$ 30,000
Questions What was the whole-farm profit margin? –Answer : 21% ($30,000 / $140,000) What was your profit margin goal? –Answer: 25% Was your own labor covered in the income statement? –Your income statement is primarily for you so put it in the form that will help you make decisions.
Discussion What do you do if your major products had an operating profit margin over your goal and yet your whole-farm operating profit margin was under? –Were you consistent in how you accounted for revenue and expense items between your enterprise budgets and whole-farm records? –Are your non-signature products heavily capital or labor-intensive?
Discussion – More questions –Are you in the development stage of your business? In other words are you trying to promote a new marketing outlet and/or product that will take time to become profitable? –Are you at the right scale of operation regarding all your products? Do you have a lot of machinery expense for a non-profitable enterprise? If yes, could this be accomplished in another manner.
Summary Improving profitability can occur one of two ways: –Increasing your profit margin per unit while maintaining sales levels –Increasing your sales levels while maintaining your profit margins. Enterprise budgets can be used to determine current profit margins and determine where they can be improved.
Summary Partial budgets can be used to determine how changes in your farming operation can improve profitability. All of your signature products should have profit margin equal to or greater than your profit margin goal (think of the 80/20 rule to determine your signature products).
Summary If you are below your profit margin goal, what can you do to make it better? –What are the opportunities for increasing your price – do you have the right customers? –What are the opportunities for changing production practices (to increase production levels or reduce expenses) or product mix?
Summary – Improving Your Profit So, how would you evaluate your business and improve your profits? How would you choose what to implement and what not to implement (what would the basis for your decision to be)?
Questions….. Any questions or comments? Thank You for This Opportunity! Craig A. Chase Marketing Food System Initiative Program Leader Iowa State Local Food and Farm Program Coordinator Farm Management – Local Food Systems and Alternative Enterprises 209 Curtiss Hall Iowa State University Ames, IA 50011 (515) 294-1854 firstname.lastname@example.org http://www.extension.iastate.edu/agdm/fieldstaff/cchase.html