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.
Simplified Enterprise Budget
Salad Greens (4x100 ft bed)
Revenue: 30 lbs @ $5.00/lb
Crop inputs: (Seed, fertilizer, etc.)
Labor
Supplies
Ownership (machinery, land, irrigation)
Total production cost
Marketing costs
Profit margin (%)
$150.00
7.00
28.00
1.00
11.00
$ 47.00
$ 50.00
$ 53.00 (35%)
Simplified Enterprise Budget
Green Beans (4x100 ft bed)
Revenue: 120 lbs @ $3.00/lb
Crop inputs: (Seed, fertilizer, etc.)
Labor
Supplies
Ownership (machinery, land, irrigation)
Total production cost
Marketing costs
Profit margin (%)
$360.00
25.00
180.00
4.00
11.00
$ 220.00
$ 68.00
$ 72.00 (20%)
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.
Profit Margin Analysis
Revenue
Total Costs
Profit Margin
Carrots
$ 136.00
102.00
$ 34.00 (26%)
Specialty Green
Beans
Greens
$ 360.00
288.00
$ 72.00 (20%)
$ 150.00
97.00
$ 53.00 (35%)
Heirloom
Tomatoes
Potatoes
$ 700.00
443.00
$ 257.00 (37%)
$ 150.00
126.00
$ 24.00 (16%)
Snow Peas
$ 175.00
153.00
$ 22.00 (13%)
Profit Margin Analysis
• 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?
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 breakeven 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 Effects
Increases in revenue (1)
Negative Effects
Decreases in revenue (3)
Decreases in cost (2)
Increases in cost (4)
Labor developing transplants
$100 Transplants ($.25 ea)
Crop inputs (soil mix, seed, etc.)
50
Total decrease in costs
$150 Total increase in costs
$250
Total positive effects (5)
$250
Net change (7)
$150 Total negative effects (6)
$250
-$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 Effects
Increases in revenue (1)
Decreases in cost (2)
Labor (50 hrs)
Total decrease in costs
Negative Effects
Decreases in revenue (3)
Increases in cost (4)
$500 Labor (1 hrs)
$ 10
Capital recovery cost
180
Taxes, housing, insurance (1%)
20
Repairs and maintenance (2%)
40
$500 Total increase in costs
$250
Total positive effects (5)
$500 Total 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 Effects
Increases in revenue (1)
Institutional market sales
Negative Effects
Decreases in revenue (3)
$3,600 Farmers’ market sales
Decreases in cost (2)
Farmers’ market labor costs
$1,200
Farmers’ mkt. supply, trans. costs 400
Total decrease in costs
$1,600
Total positive effects (5)
Net change (7)
Increases in cost (4)
Institutional market labor costs
Inst’l mkt. supply, trans. cost
Total increase in costs
$5,200 Total negative effects (6)
$0
$4,500
$600
100
$700
$5,200
Toss-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
cchase@iastate.edu
http://www.extension.iastate.edu/agdm/fieldstaff/cchase.html