Last month, we discussed the three actions a producer can take to increase profit: Decrease overhead costs; Improve gross margin per unit; and Increase tu rnover (the number of units).
Only one of these three things, however, is the most important. The importance depends on your personal situation. If high overheads are the problem, increases in production efficiency are likely to increase your work load but may not significantly increase profit. If gross margin is the problem, then decreasing overheads won't have much effect and increasing turnover may actually help you go broke faster. It isn't enough to know the numbers. We must find out what the numbers mean.
The diagram below shows the thought process we have producers use to diagnose the problems and opportunities in their businesses.
We calculate profit by adding the gross margin for each enterprise and subtracting overheads. If the difference is positive the business made profit. If it is negative the business lost money.
Gross Margin (enterprise a)
+ Gross Margin (enterprise b)
+ Gross Margin (enterprise z)
- Overhead Costs
= Profit (Loss)
Profit is calculated by subtracting overhead costs from gross margin. So if profit is low, it is either because gross margin is too low or overheads are too high.
Gross margin is calculated by subtracting direct costs from gross product. If gross margin is too low, it is either because direct costs are too high or gross product is too low.
Gross product is a measure of how much we produced and how much we got paid for it. So, if gross product is too low, it is either because we didn't produce enough (production), or we didn't get paid enough for what we produced (price).
If we didn't get paid enough, it is either because the market is too low or our marketing is not adequate. For example, if the gross product is low but the price is reasonable, then production is too low. If production is low, it is either because we didn't produce enough units (reproduction) or because what we produced weren't big enough (gain).
If gross margin is low but gross product is not the problem, then the focus turns to direct costs. There are two major direct costs: feed costs and health-related costs.
If gross margin is healthy but the business still isn't profitable, the problem may lie in the overhead cost category. There are two kinds of overheads: land costs and labor costs.
There are only two kinds of land costs: the cost of getting land (e.g., lease payments) and the cost of maintaining the land and the improvements on it.
If land costs aren't the problem, the focus turns to labor. There are two major labor costs: costs associated with people (i.e., salaries, retirement plans, health benefits, etc.) and costs related to vehicles and other equipment.
But we also know that cutting overheads and improving gross margins aren't the only ways to increase profit. Increasing turnover is the third way to increase profit. If gross margins are healthy and there's no room left to cut overheads, then turnover is probably the most promising way to increase profit.
Using this thought process as a guide, our students often find that things they assumed would make their businesses more profitable may actually make the situation worse. This procedure can help you pinpoint problems and opportunities in your business too. That's essential if you want to be Ranching for Profit.
David Pratt of Ranch Management Consultants teaches the Ranching for Profit School. For more information visit www.ranchmanagement.com, or contact him at 707/429-2292 or e-mail: [email protected]