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Bad accounting Part 1

Today's ranch businesses are dramatically different from those of years ago. Previously, profit margins were such that the more beef you produced, the more profit you made. Ranching's business-side was simple enough you could run the business from your head.

Today's ranch businesses are dramatically different from those of years ago. Previously, profit margins were such that the more beef you produced, the more profit you made. Ranching's business-side was simple enough you could run the business from your head.

Published Farm Business Management data suggests profit margins per cow are shrinking each cattle cycle, however. Similar to bygone times, ranchers' response has been to run more cows. But as ranch businesses get bigger, on-farm management info becomes more important, making it harder for ranchers to effectively run the business from their heads.

The business side of ranching has changed. Some ranchers now realize production and financial records are an integral part of the business side of ranching. These ranchers routinely use on-farm production and business accounting records in their management decision-making.

Other ranchers, however, still rely on the old business model that approaches management totally from memory. No production records are maintained and the only financial records generated are for IRS tax-reporting purposes.

In many cases, the ranch wife does that accounting, but it's for the taxman — not the ranch manager. The only on-farm management info used in decision-making comes from memory.

Kitchen-table experiences

I'll begin this discussion on business records by sharing some of my kitchen-table experiences to illustrate how some ranchers are being failed by their lack of on-ranch records.

If you want to know where you're making money on your ranch, divide your total ranch business into profit centers, then treat each as a stand-alone business. One profit center should be your beef cows; another could be your hay production for your cows.

Backgrounding your calves, marketing your calves as calf-feds, or even feeding out your cull cows are all examples of post-weaning profit centers. By treating each profit center as a stand-alone business, you learn where you're making — and where you're losing — money.

Three case examples will demonstrate how ranchers are being let down by their on-ranch business record systems.

Case No. 1: Do you want a surefire way to turn a profit with retained ownership of your calves? Ask your custom feedlot manager for a closeout sheet with no value placed on the calves going into the lot. Some ranchers actually do this; it's an example of how an on-farm accounting system can serve a rancher poorly.

I can't count the number of times ranchers have told me about all the money they made backgrounding their calves. But in arriving at that conclusion, they generally included all profits generated by running the beef-cow herd (the pre-weaning profits) in with the backgrounding profits.

Case In Point: A rancher in 1994 told me: “Harlan, I made more money backgrounding my 1993 calves than I've ever made. I made so much money backgrounding calves last year that I'm going to buy some calves to background with my own this year.”

In 1993, just as in 2006, calf prices were record-high. In fact, 1993 was a year of record profits in the last cattle cycle from the perspective of the beef-cow profit center. Meanwhile, marginal profits at best were generated from post-weaning profit centers (again, it sounds like 2006).

Let down by his own on-farm business accounting records, this rancher was about to expand the wrong profit center, something that happens all too often in production ag.

Case No. 2: A sure way to make money in a post-weaning niche profit center is to not price the calves going into that niche marketing program. Then you transfer all the pre-weaning profits into that niche marketing program. It works every time!

Case In Point: Just this year, a rancher told me: “I made more than $200/head in my niche calf-fed marketing program.” He was planning on expanding his calf-fed program to include more niche-finished calves.

Published 2005 Farm Business Management Summaries indicate Northern Plains beef-cow producers averaged $211/cow from traditional pre-weaning programs. Once again, I think this rancher was let down by his own on-farm business records.

Case No. 3: I continuously hear comments about how low beef-cow profits are — even with today's record calf prices. The sure way to arrive at this conclusion is to use cash-accounting records rather than business profitability records.

Ranchers, in general, are being led down a primrose path by cash accounting done for IRS income tax reporting purposes. (Incidentally, production ag is the only U.S. industry allowed to use cash accounting.)

Case In Point: A ranch family used Quicken® computer software to do its on-farm accounting. All cash transactions, both business and family living draw, were entered into the program to generate monthly reports and a year-end business cash flow summary, with family living and business expenditures included.

It turned out the excessive family living draw was dragging down the accounting cash flow summary. My analysis of that ranch suggested the beef-cow herd actually was quite profitable.

In addition, this rancher was expensing the capital purchases of multi-year assets (including replacement females, farm machinery, etc.) totally in the year purchased. While this is legal for income-tax purposes, it's not the recommended managerial accounting practice.

From a business-management standpoint, multi-year assets should be expensed (depreciated) over the asset's life — not just in the year of purchase. Yet, many ranchers typically do this in cash accounting.

What happens is that, in years of high calf prices, ranchers make added purchases of multi-year assets but charge them all off in the year purchased. This leads the rancher to conclude that, even with record-high calf prices, he didn't really make more money.

By the way, my Integrated Resource Management databank doesn't support the contention that the rancher's cost per hundredweight of calf is increasing each year. The cost that is going up every year, however, is iron — iron that applies primarily to the hay-profit centers.

My data suggest the cost of producing the hay to feed to beef cows is going up — in some cases, quite dramatically. It suggests ranchers with high hay-production costs should investigate buying hay rather than the iron to produce it.

My four recommendations are:

  1. Ranchers need to break their ranch businesses into profit centers, and then treat each profit center as a stand-alone business.

  2. Ranchers should always price their calves at weaning, regardless of how they market their calves.

  3. Ranchers must calculate pre-weaning and post-weaning profits to know where they're making their money.

  4. Cash accounting isn't a measure of business profits. In fact, it can be very misleading if used as a measure of 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].