5 simple adjustments to boost on-farm profitability
The decisions farm managers make require a keen understanding of risk and reward.
Farmers are resilient, nimble and able to embrace change like few others. Whether agronomic or economic, the decisions farm managers make require a keen understanding of risk and reward, and the difference between the two is razor thin. But a distinction does exist.
FCC vice-president and chief economist J.P. Gervais, and Saskatchewan farmer Kristjan Hebert, CPA, provided insight on five key drivers for remaining profitable in 2022 and beyond.
1. Plug the leaks
It’s relatively easy to find big issues, but what about the small leaks that are lost over time due to lost revenues, unchecked expenses or complacent business practices?
Your farm business’s profitability is composed of a series of large and small elements that add up to a larger sum. Don’t assume that just because something is small, it’s not important.
Before planting season begins, a mechanical inspection of all machinery, including changing belts and topping fluids, seems like a small piece. But if machinery begins operating at a reduced capacity because steps were overlooked, you have small leaks and losses may ensue.
Hebert believes there are three key areas that regularly leak:
- land, buildings and finance
- interest rates
- labour, power and machinery
Even fuel and other inputs are regularly overlooked areas. With finance especially, do a deep dive annually with your lender. “Be on the same page of what the needs will be for next year.”
2. Actively manage your cost of production
How does one do this well? It’s not as easy as it seems. Many costs are fixed, so dig deep to find malleable areas where costs can be reduced.
“It’s important to know your cost of production, but more important is the notion that we must actively manage it throughout the year, not just once every winter when reviewing expenses,” Gervais says.
Running what-if scenarios is critical as well. Challenge yourself to plan for opportunities and risks. This will give you options. Avoid sitting idle or operating on only gut feelings, which are much less reliable than a well-designed business plan. Look to innovate.
Many farmers enjoy the technical, production side of the barn, feedlot or orchard, but aren’t excited to sit at the computer and do business.
“If you combine that experience out in the field with management skills you can deploy sitting in front of a laptop, you can start to affect positive change on your cost of production,” Gervais says.
He gives the example of a dairy farmer who wants 100 kilograms of butter fat at their operation. “Maybe you have some flexibility,” he points out. “Perhaps this year you don’t get to 100, maybe it’s 95; but given what you want to achieve, how do you minimize cost, knowing all those different costs associated with production goals and targets?”
Once you answer that, he says, you can pick and choose what variables can be changed via a revenue-minus-cost comparison. “So, if it costs X per kilogram of butter fat, what could be done to bring that cost down and still achieve the same result?”
Perhaps it’s an automated milking robot or new floor; it could be many things. Take the time to investigate what could be changed to achieve a better long-term result.
For Hebert, managing 26,000 acres of cropland is manageable because he has a strong team in place that’s right for his farm. “That’s what gets all the execution done. The minute farms are short-handed but over-equipped, that gets expensive. You must optimize each hour of your machinery. Are you optimizing its utilization? If the answer is no, then you need to make an adjustment.”
Beyond knowing the costs, know how to manage costs actively. Rather than looking at year-end financial statements, Hebert suggests a variance analysis up to four times per year. “Knowing your [costs] based on prior year and having an annual plan of areas to be more efficient to tweak that cost, is important,” he says.
Hebert runs what-if scenarios. These include a continuum of worst-case scenarios to very optimistic numbers, in increments that make sense for his business. They provide a clearer picture of what such scenarios mean for debt servicing and working capital.
3. Have a marketing plan
Marketing goes to revenues, and revenues are split into prices of what you sell and the prices you’re getting. Even though you have little control, time is of the essence when working with the market to boost profit.
“It’s not just about boosting profitability, it’s also to reduce volatility,” Gervais says. He explains both must be held in balance, despite being difficult. Risks must be taken but must also be calculated.
At a field level, Hebert makes it clear: "Cash flow is the driver of your marketing plan, and you want your marketing plan to determine your cash flow. Not the other way around. If the bank or retailer is phoning you for a payment and that’s what causing you to sell your product, that’s a bad marketing plan.”
He agrees with Gervais on increasing profitability and reducing volatility. However, one typically takes precedence over the other. “But if you have cash flow, you can go after reducing volatility and increasing profitability,” he says.
Consumers are more demanding than ever. Across the supply chain, businesses have responded to create products that align well with consumers’ wishes. By marketing foods with specific attributes or production methods, countless avenues have been opened for farmers to differentiate themselves in crowded marketplaces. Many scoff and say, “that’s just marketing.” And they’re right.
“Many of the practices consumers demand from farmers today are already being done. The only difference is that some have realized [and are] properly telling their story, a risk to be sure. By engaging with the public there is additional margin and value to capture,” Gervais says.
Who wouldn’t want an extra $15 to $20 per head of beef per sale if all they had to do was fill out a few hours of paperwork? Or get a higher value per hundredweight by emphasizing a pre-existing attribute of their potatoes? While growing your farm business to a larger economy of scale can increase profitability, there is just as much untapped value in differentiating product attributes, and it’s often easier than you think.
Hebert looks also at value-added from unique perspectives, such as offering farm tours for high school students and potential employees or inviting a landlord out to a harvest supper and asking about how aspects of the land could be improved via collaboration. “Be cognizant of what you need to do more of,” he says.
4. Business plan
While some may feel a business plan is for the behemoth businesses of the world only, it’s a real asset for an operation of any size.
The first thing any good business plan requires is putting pen to paper. Without a written plan, details will simply float around your head or get lost. When you pick up a physical copy of a business plan, it can be reviewed in sections or as a whole.
It’s also a dynamic document that can be changed routinely. For example, many producers made changes to their business plans during the COVID-19 pandemic, and it served them well.
If it feels daunting to create a business plan on your own, enlist the help of trusted external third-party advisors. After all, you do this with other aspects of your business via an accountant, lawyer, agronomist and veterinarian; a business plan should be no different.
“To graduate from the ranks of farm manager and move into the CEO role and take your farm to the next level, understand that you simply cannot be the single expert voice on every subject,” Gervais says.
Rely on the experts you hire and the third parties you work with to steer your business in the proper direction. To relinquish control is never easy, but it can be necessary. As Jim Collins explains in his book Good to Great, what brought your business to where it is today (good) will not get you to the next step (great) unless a new plan is formulated. Sometimes we just have to get out of our own way.
Hebert believes the biggest benefit of having a business plan – and sharing it with everyone – is the buy-in this creates for the entire farm team. It helps them see the value in their work. “Explaining what you are doing, getting buy-in and giving them a chance to be heard – that gives them a sense of purpose. Without it, they lose that fire in their belly.”
5. Five per cent rule
Forget the notion you must grow by 20 per cent or double year-over-year margins. You may have success for one, maybe two years, but to repeat the process indefinitely will only cause frustration as you realize the limitations of expecting massive gains while implementing little change.
An effective principle is the five per cent rule. That is, by adding or subtracting five per cent on various areas of production you become more profitable.
The power of the 5% rule becomes apparent with some simple napkin math. For example, if an enterprise currently has costs of $500,000 and gross revenue of $625,000 the margin is $125,000. If costs can be cut by 5% and gross revenue increased by 5% the end result is costs of $475,000 and revenue of $656,000. Margin is increased to $181,000 – 45% higher than before the improvements.
“The whole point is to stop looking for unicorns to fix your business,” Hebert says. “Look for small incremental changes that will change your business.” You need to be aware of how little things compound.
He says it’s more of a mindset than a rigid series of changes that must be accomplished within a season. He encourages farmers to invest five per cent not just in machinery and costs of production, but also in people. “By empowering them we get more efficiency and optimization on everything. They execute on everything at the farm.” He says that if a worker is happy, that worker’s family is often happier, which is a feedback loop and makes work at the farm more productive and efficient.
So, is it a five per cent benefit? “Not even close. It’s thousands of per cent,” Hebert says.
From an AgriSuccess article by Trevor Bacque.