Managing a farm or ranch is never easy, but it's especially difficult during drought and its aftermath. Integrated business planning (IBP) can help you work through the overload of information in formulating a drought recovery strategy targeted for today's markets and beyond.
IBP considers the farm or ranch business as a chain of three economic links: overhead, gross margin and turnover (business size). (See Figure 1.) There are only three ways to increase profits in any business: increase gross margins, decrease overhead costs or increase turnover.
Overhead costs are those that don't change as livestock numbers or crop acres go up or down. There are three kinds of overhead costs: land, labor/management and equipment. For analysis purposes, we often use the family living draw as a proxy for labor/management wage.
Economists label overhead costs as fixed costs that are independent of the number of animals or crop acres, but overhead costs can be reduced. In fact, reducing overhead is an effective, often overlooked, way to increase post-drought profits.
Gross margin is a measure of the economic efficiency in your livestock and cropping profit centers. To determine where you're making your profits, break your business into profit centers and calculate the gross margin for each. Calculate that gross margin by subtracting that profit center's direct costs of production from its gross income.
Gross profit is the sum of gross margins from all profit centers added together. Meanwhile, net farm income is determined by subtracting overhead costs from gross profit. Net farm income is the bottom line for a farm or ranch business.
Turnover is a measure of the size of the ranch business: the higher the turnover, the larger the business. Most increases in turnover add to overhead costs. As a result, you must budget through a proposed turnover increase to determine if it adds to, or subtracts from, total profits.
The Decision Process
The recommended process for increasing profits is to “get better before getting bigger.” A suggested procedure for “getting better” is outlined in Figure 2.
Only two management areas impact each point on the profit graph. Starting on the left side, profit is the difference between your business's overhead and gross margins. Any rancher wanting to increase his business profits needs to either increase gross margins or decrease overhead.
Gross margins can be increased by either increasing gross product or decreasing direct costs of production. Gross product can be increased either by selling for a higher price or increasing units produced. Selling for a higher price is done either by selling in a different market or marketing a different product. Increased production (from a beef cowherd) has to come from either increased reproduction or more gain on existing animals.
If your gross margins are maximized and you seek further improvement, look at reducing overhead costs. Do this by reducing either land costs or labor costs. If land costs are too high, it's because acquired land was over-priced compared to its productivity, or the costs of maintaining control over existing land are too high. If labor costs are too high, either the family living draw is too high or the equipment costs associated with existing labor are too high. Examples are having a pickup for each employee or having more tractors than drivers.
The reality is that ranchers managing in a drought seldom reduce overhead. In fact, a well-known financial consultant says that, among his clients, 15% of them carry unnecessary overhead. Cutting overhead is where I'd focus drought-management strategies.
If gross margins are maximized and there's no room to “get better” by reducing overhead, then “getting bigger” through increasing turnover is the most promising way to increase profits.
For ranchers who downsized as part of their drought strategy, increasing turnover (size) is a logical post-drought management strategy. There's no guarantee, however, that repopulation with relatively high-priced females financed with borrowed capital will add to overall business profits. Adding more cows only makes sense if you can generate high gross margins from them.
Ranchers with low gross margins on their beef cows will find that adding more females with borrowed money can lead to severe financial stress and challenge long-term survival. Budget your repopulation strategy through several years of expansion before signing the dotted line. Know your herd's gross margin before you add more females to the herd.
Tough Actions Are Called For
Most ranchers will spend most of their management energies looking at getting bigger rather than first getting better. When working to get better, look at the items on the far-right side of Figure 2 rather than the items on the left side. Changing the far-right items won't save a drought-impacted farm or ranch business in today's economic climate.
Today's times call for tough actions. If you're serious about putting your drought-affected ranch back in the black, get better before you get bigger. Working on gross margins and overhead is the best way. Only then should you look at increasing turnover by adding more cows.
Harlan Hughes is a North Dakota State University professor emeritus. He lives in Laramie, WY. Reach him at 701/238-9607 or [email protected].