Scale Does Not Equal Profit

January 29, 2012 11:05 PM

Oftentimes, we think we need to be big to be profitable. That is not the case. In working with farmers and following their financial progress for many years, my colleagues and I have discovered there is little correlation between profitability and the size, type or location of an operation.

The chart below contains data from selected clients of ours showing their return on assets and return on equity throughout a number of years. The results reflect four key areas that
affect profitability and a fifth that is less important but can also add to the bottom line.

Balance sheet math. The first area that separates farmers from their competition is marketing. Good marketing results can add up to $300 per acre extra income. If you are not selling your products in the top third of the price range for the year, work with someone who can help you get there.

The second area of great leverage is managing machinery cost per acre. Machinery depreciation, interest and repairs can total 25% of the balance sheet value of equipment each year.

In benchmarking one operation against another, we allocate 10% for depreciation, 10% for interest or opportunity costs and 5% for repairs. In our database, the range in machinery cost per acre is $25 to $200, and again, there is no correlation with size of operation.

Another profit leverage point is labor cost per acre. The range in our database is $5 to $125 per acre. We figure labor cost per acre by taking a family living draw from the operation or paid wages, adding hired labor and dividing the total by harvested acres. I have had clients say, "But Moe, I have three daughters in college." I respond, "Does that hit your checkbook?" They say, "Yes, big-time!" I say, "That affects your competitive advantage."

Conversely, I have a customer whose spouse is a pharmacist, and they take no draw out of the farm for family living expenses. There again, it affects their competitive advantage and bottom line.

The fourth area of increasing profit margins is agronomic management. There are many ways to improve in this area, with advantages of up to another $100 per acre.

The last area that separates those that make good returns from others is reducing input costs, but compared with the opportunity in "chasing the top four rabbits," it pales in comparison.

Producers spend much of their time trying to reduce input costs for several reasons. First, it is the most visible area. You write checks for these items—big ones. You do not write checks for lost opportunity in marketing or agronomic management.

Second, input suppliers are the closest ones to let your frustrations out on because they are frequently an important part of your business.

The third reason is that if cost-cutting is done in the wrong areas or by using products that are not high in quality or backed by assurances and a knowledgeable sales staff, it can cut into your bottom line.

p28 Scale does not equal profit Chart

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