Spring rains in cow country are turning many ranchers' attention toward drought recovery. For some drought-affected ranchers, that means repopulating the herd.
The primary negative economic impact of a drought isn't felt in the actual forced liquidation phase but during the repopulation phase. Holding back heifers and buying replacements both reduce net income for the next several years. This decade's projected cattle cycle and its resulting beef price cycle will affect the long-run success of repopulation strategies in a major way.
If you plan to repopulate, be sure to consider the economics of your plan before you sign any dotted lines. Your actions in the first or second year following a drought will determine your ranch's potential for profit (or loss) for the rest of this decade.
This column is the first in a series that will focus on the economics of repopulating a drought-reduced cowherd. This month, I introduce my EZ-Way analysis for current drought-impacted ranch businesses. In subsequent columns, I'll use the tool to guide you through an economic evaluation of your drought recovery strategies.Doing It The EZ-Way
An accurate analysis of any drought-affected farm or ranch business must be based on data specific to that ranch. Kris Ringwall, a North Dakota State University animal scientist, defines on-farm data as “factual information used as a basis for reasoning, discussion and calculation.” He adds, “On-farm data is where long-term drought solutions and planning are born.”
The top half of Figure 1 presents the production and business accounting data for my Northern Plains case farm. It's a mixed farming and beef cowherd business consisting of 1,529 acres of owned cropland, 1,200 acres of pasture and 153 beef cows. This business is divided into three profit centers: cash crops, feed crops and beef cows selling calves at weaning.
A simplified accounting summary for this case ranch is presented in the bottom half of Figure 1. This ranch's 2002 gross income from the three profit centers was $187,116.
Direct operating expenses for the year totaled $87,853, which figures to a gross profit (aka: net operating income) of $99,263 from all profit centers. The 2002 overhead for this business was $71,018, which generated an annual net profit of $28,245.
The right-hand column of Figure 1 summarizes this same accounting data in percentages. Of all gross income, 47% was consumed by direct operating expenses. While this implies that gross profit made up the other 53% of all gross income, overhead costs consumed 38% of gross income. Thus, this ranch's net profit margin was 15.1% of gross income, or 15¢ of each $1 of gross sales for this ranch was profit.
Now, let's do my Ez-Way graphical analysis of this ranch data. Only three numbers are needed: total overhead costs, direct costs per $1 of gross income generated, and total dollars of gross income generated during the year. You can get these three numbers from your federal income tax forms and associated farm business records.
With these three numbers, we can determine a ranch's business profits, breakeven volume and average net profit margin. Now, let's build an Ez-Way graph.
Step One: Design the graph ( Figure 2) so the horizontal axis represents gross income dollars and the vertical axis represents total cost dollars. Next, plot total overhead costs on the graph by finding the point on the vertical axis that represents the dollar value of the overhead and drawing a line straight across to the right (see blue line).
Label this line “overhead costs” ( Figure 2). This line signifies that overhead costs don't change as gross income increases and/or overhead costs don't decrease as cattle are liquidated in a drought.
Step Two: Plot the direct costs (direct operating costs) on top of (added to) the overhead costs. In this example, direct costs were 47¢ for every $1 of gross income generated. So $100,000 of gross income costs $47,000 of direct costs (purple line).
Because the cost is the same for each $1 of income generated, put a specific mark on the graph at the intersection of $100,000 on the horizontal axis and $118,000 on the vertical axis (determined by adding the $47,000 direct costs to the $71,000 overhead costs). Then draw a straight line from the marked point to the leftmost beginning point of the overhead cost line. Label this line “total costs.”
Step Three: Add a gross income line by putting a graph point at the intersection of $100,000 on the vertical axis and $100,000 on the horizontal axis. Draw a line out of the origin through this point and label this line “gross income” (green line). We now have an EZ-Way graph for our case ranch.What The Graph Tells Us
Notice that for this case herd, the total gross income line comes out of the origin and goes through the total cost line at $134,000 (red x). This signifies the breakeven gross income for this ranch.
Actual 2002 income was $187,000, so the gross income exceeded the breakeven income level by $53,000. Since it cost 47¢ to produce each $1 of added gross income, this extra $53,000 generated $28,000 of net profit.
Divide this $28,000 by the total gross income, and the calculated gross profit margin is 15.1% of gross sales. Thus, the profit margin of each gross income dollar generated was 15.1¢.
What was the profit margin of your ranch last year? Was gross income above or below your breakeven level of gross income?
This month, generate an EZ-Way graph for your ranch. Next month, I'll discuss how to use it to increase your ranch profits.
Harlan Hughes is a North Dakota State University professor emeritus. He lives in Laramie, WY. Reach him at 701/238-9607 or [email protected].