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Knowing Your Costs

My clients continually educate me on the regional anomalies relating to land prices, and specifically land
rents. The common opinion among most farmers I speak with is that some of their neighbors just don’t
understand how to measure costs, and this leaves many farmers (including some of those I speak with)
feeling left out in the cold as they watch land get snapped up by someone willing to pay a rental rate
that can appear astronomical.

Based on third party feedback, meaning info shared with me by a farmer from his/her conversation with
a friend/neighbor/competitor, most decisions to take on land are being justified under the guise of
“reducing equipment costs per acre” and/or “the drive to be bigger.”

Popular ag-economics has drilled in to everyone’s head that fixed costs, like equipment, need to be
spread out over more acres to reduce the fixed costs per acre. This is simple arithmetic, and is
mathematically correct if we stop there. Stopping there allows us to feel good about the decisions we’ve
made to increase our fixed costs because “over ‘X’ acres, we’re only spending ‘Y’ dollars per acre.”

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Of all the costs that farmers face, the costs they have most control over seem to be the costs that are
least controlled. MNP has coined the term LPM, and what I’ll call “operations” are a farm’s labor, power,
and machinery costs which have ballooned in recent years. Next in line is Land, Buildings, and Finance
costs, or what I’ll call “facilities,” which have also grown significantly. Increase land costs (rent) to justify
increased equipment costs: think about it, we’re increasing costs to validate increased costs…
We expect to make a profit from taking risk. The more risk we take, the more profit we expect. My
concern comes from witnessing decisions that magnify risk and leave the expectation of profit as a
secondary, or even tertiary, consideration.

Direct Questions

Take a look at your expected gross margin this harvest. How much gross margin will you have available
to contribute to “operations,” “facilities,” administration costs, and PROFIT?

What is your “operations” cost? What are your target costs for “operations?” Did you know the most
profitable farmers keep their “operations” cost below $100/ac?

Have you traced your line from gross revenue and gross margin through to costs and down to profit?
Where can you improve?

From the Home Quarter

We cannot eliminate risk, we can only manage it. We cannot eliminate expenses, we can only manage
them. We cannot manage what we do not measure. If the purpose of your business is to increase profits
and grow your wealth, should you not ensure that the risks you take and the expenses you incur fit into a plan
for profit?

 

Understanding Costs – a graphical simulation

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In the example above, which illustrates a generic but common scenario on average grain farms in 2015,
a net loss of $9/ac is expected. But the top 10% of farms with a similar gross margin could show a net
profit of $40/ac, simply from excellent management of their controllable expenses: operations, facilities,
and admin.

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Austerity

We’ve been hearing the word “austerity” in the media for quite a while now. Whether it be issues in the
EU, or right here in Canada (Quebec), it’s become a “buzz-word” as of late.

Merriam-Webster defines austerity as “a simple and plain quality; a situation in which there is not much
money and it is spent only on things that are necessary; austerities: things that are done to live in a
simple and plain way.” http://www.merriam-webster.com/dictionary/austerity

Based on that definition, I like what that word represents. Maybe that’s because I grew up on a small
mixed farm in Saskatchewan in the 80’s. There wasn’t a lot to be had that wasn’t “necessary.” Don’t get
me wrong, we never went without the necessities, but I wore $20 running shoes from Army & Navy, not
Nike Air. I guess I was raised under austerity.

There was an article published in Country Guide this spring titled “Have Higher Farm Incomes Changed
the Way You Think?” It opens by describing the near perfect correlation of rising farm income to rising
new farm equipment sales. The fourth paragraph reads; “So the question is, do those periods of high
incomes create a kind of euphoria or recklessness that induces farm managers to make longterm financial decisions that could seriously reduce profits in future years, especially if revenues
fall?”

I think we know the answer to that question. And, so what now?

Well, who is considering an austerity plan for their farm?

Remember, austerity is spending only on things that are necessary. It’s easy for us a humans to blur the
lines between “nice to have” and “need to have” because we allow emotion to interfere with our
decision making.

Needs

  1. Bushels.
    You need to maximize yield in the most efficient way possible to produce at the lowest Unit Cost
    of Production your farm can provide. An Agrologist can help and should prove his/her value
    every year.
  2. Cash Flow.
    You need positive cash flow to meet debt and lease obligations, pay for inputs, land rent, wages,
    etc, etc, etc. Grain marketing is often where the best gains can be had, or can be lost. Diligent
    marketing with quality information (or lack thereof) can make or break any farm.
  3. Above Average Management.
    As you read in Growing Farm Profits Weekly Issue #17, average management was sufficient in
    the boom years, but it won’t get you through the next business cycle. Even above average
    managers find confidence in having a business advisor offer independent, unbiased advice on
    current situations, strategic plans, and risk management.

The list of “nice to have” could fill more pages that you’d care to read, or than I’d care to write. The list
of NEEDS is not exhaustive either, but in the spirit of austerity, those are the big 3 that NEED focus
(pardon the pun.)

Direct Questions

Production alone will not keep every farm afloat through the next business cycle. Are you able to
elevate your management abilities (no matter what level you’re currently at) to offer your farm its best
chance to thrive (or at least survive?)

Somebody shared a quote on Twitter that I read today: “Successful people are like a turtle on a fence
post. They didn’t get there by themselves.” -Michael Pinball Clemons
Do you have an arsenal of trusted advisors working for you to ensure you do everything it takes to be
successful?

Will your austerity plan be cutting the right costs or just the easy ones?

From the Home Quarter

It’s been said “You can’t shrink your way to greatness.” When it comes to cost cutting in an effort to
preserve cash, there is a wrong way to do it. Similar to the thinking of “good debt and bad debt,” there
are costs that should be cut, and costs that must not be cut. Interestingly enough, my phone has been
ringing lately with the voice on the other end saying, “Things are looking tough, I can’t afford to make
any mistakes. I need your help now more than ever.”
That’s what I’m here for, glad you called.

If you want help with building an austerity plan or just guidance on daily strategic decisions, call me or send an email.

life

Life…Another Cost to Manage

“Despite the high cost of living, you’ll notice how it remains incredibly popular.”

We enjoy many benefits from living on the farm. So many are intangible: peace and tranquility, open
skies, fresh air, etc. Many others are tangible: be your own boss, grow your own food, continue a family
legacy, etc. Then there are those benefits that are measureable but rarely measured.

Any farm business doing even the slightest degree of cash flow analysis must give full disclosure on
personal expenses paid by the farm. There, I said it.

We all know that the farm pays the power, heat, taxes, and maintenance on the house; it buys the
vehicles, insures them, and put fuel in them. These are legitimate business expenses, whether it be a
portion of each or the entire cost. The point is, “Are you measuring it?”

This hits home for retiring farmers who are trying to calculate how much they need to live on in
retirement. Many of them are not used to paying for all of that, and more, from their personal
income…and all of the sudden they realize that CPP and their RSPs are barely adequate (if adequate at
all.) Interestingly, the intention of gifting the farm assets to the next generation isn’t as likely unless
mom & dad are going to frequent the food bank in their golden years.

Farmers that are paying themselves a salary, wage, or dividend from the farm and are truly paying their
personal (as in “non-business”) expenses from that personal income already have a clear grasp on this
concept. They understand the “pay yourself first” mantra and won’t be surprised at just how much it
costs to live when they transition out of farming.

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I’m not saying that you must discontinue letting the farm pay for personal expenses; after all, it’s your
business. What I am saying is that you must measure it; you must know what that number actually is on
a monthly or annual basis. Picking a number that you “think” is close is not sufficient. Knowledge is
power; estimating is risk.

Direct Questions

Have you calculated how many personal expenses are paid by the farm? If not, why not? Saying that you
don’t want to know is not an acceptable answer.

If you are measuring it, what are you doing with the information?

From the Home Quarter

As a business owner, you have every right to operate your business how you see fit within the confines
of the law. But if you truly want to measure the level of success your business enjoys, this is one more
metric that must not be ignored. If you are afraid to know just how much you are spending personally,
that’s even MORE of a reason to do this, not less. In an era of tight margins, don’t we owe it to our
business, and ourselves, to manage every dollar appropriately?

Cost of Production

I got a little worked up last week when I saw a tweet that read “Cost of production matters in 2015 –
The Western Producer” and included a link to the article. Even though that wasn’t the article’s title, I still
had to sit down and scribe this.

Let me be very clear: cost of production matters every year. Period.

Cost of Production is the most basic principle that must be employed when making marketing decisions.
If you don’t have a clear understanding of your COP, then you are putting the survival of your business
at grave risk. Why? Because how would you know if you’re selling for a profit or not?

 

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The WP article states, “A 38 bu. (canola) crop and a $9.45 price could yield $70 per acre before labour
and equipment costs.” That’s nice, but why would we not include our labor and equipment costs? Will
the crop magically seed and harvest itself?

COP only begins with your seed, chemical and fertilizer costs. It must also include all other operating
costs AND your fixed costs.

Now work back from your actual, or projected, yield and we come to the real figure that matters: unit
cost of production.

If you know that it costs your farm $6 to grow a bushel of canola, isn’t a $9/bu selling price a nice
target? By the way, that’s 50% ROI.

 

Direct Questions

What was your gross margin per acre in 2014?

Do you include your fixed costs when working out Cost of Production calculations? If no, why not?
How do you know what is a profitable selling price for your crop if you don’t know what it cost you to
grow it?

Do you discover whether or not you’re profitable only when you receive the accountant prepared
financial statements?

From the Home Quarter

In the simple calculation of “Revenue – Costs = Profit,” how can we be expected to make profitable
decisions without intimately knowing our costs? Every business that produces anything, from ocean
freighters to widgets, knows exactly what it costs to produce one item. Why doesn’t every farm know
their costs the same way?

As a special offer to the readers of this blog, I will conduct a Farm Financial
Review™ for up to 5 qualifying farm businesses at $475 (normally a $875 value.) This will include a
review of your 2014 financial results and a Cost of Production Analysis. Work must be booked by the end
of January and completed by the end of February. Please call or email for details.