Managing Your Farm’s Finances

1. Managing Your Farm’s Finances Why Farmers Need Farm Financial Management… Craig Chase – Iowa State University

2. Plan for today • Two ways to improve profitability • Increase profitability per unit (or margin) while selling the same number of units. (Focus of today). • Increase the number of units sold while keeping the same profitability per unit. • Using whole farm analysis and enterprise records…

3. Whole-farm Profit Analysis • Whole-farm profitability can be illustrated by the income statement. • You can use Quicken, QuickBooks, or other program to develop a qualified income statement. Remember that some programs Profit and Loss or Income Statements are not really Income Statements. You will probably need to make adjustments.

4. Income Statement; Yr ending 12/31/2015 Sale of products $140,000 Car/truck, gas and oil 13,200 Repairs and maintenance 12,000 Depreciation 6,000 Crop or livestock inputs 27,800 Interest expense 3,400 Insurance and taxes 15,000 Labor * 24,600 Utilities 8,000 Total Expenses $110,000 Net Income $ 30,000

5. Labor * - Adjustment • You know how some businesses keep two sets of books; one for the IRS and one for the business’s use… • The labor amount for an income statement is the dollars spent for hired labor (contributed family labor is normally not included). • However, for this analysis – your contributed labor (not management time) should be included.

6. Simple Whole Farm Analysis • The dollars you receive from the products you sell (your gross revenue or gross sales), can be divided in 1 of 4 areas: • Operating expenses (production, marketing, other direct expenses) • Interest expense (financing expenses) • Depreciation expense (capital expenses) • Net income (family living, etc.)

7. Income Statement; Restructured Sale of products $140,000 (100%) Car/truck, gas and oil 13,200 Repairs and maintenance 12,000 Crop or livestock inputs 29,800 Insurance and taxes 15,000 Labor * 24,600 Utilities 8,000 Total Operating Expenses $102,600 (73.3%) Depreciation 6,000 ( 4.3%) Interest expense 3,400 ( 2.4%) Net Income $ 28,000 (20.0%)

8. What Do These Numbers Mean? • For every dollar of sales approximately… • $0.73 is spent on operating expenses • $0.04 is spent on depreciation expense • $0.02 is spent on interest expense • And approximately $0.20 is kept by the farm to pay for family living, growth of the business (savings), retirement … • This $0.20 can also be presented as a percentage I will call profit margin (20%).

9. Margins Versus Sales • Let’s assume you want to have $40,000 to cover living expenses, retirement, etc. • And your margin is $.20 per dollar of sales (or 20%)… • How much product would you need to sell in order to reach your $40,000 goal? • $200,000 (40,000 / .20)

10. Why Margins Are Important • Now let’s say your margin is $0.10 for every dollar of sales and you still want to have $40,000 to cover living expenses, retirement, … • How much product do you have to sell? • $400,000 (40,000 / .10)

11. Reality Check • Understanding margins provides you a reality check related to the scale (size) of your business. • If your margin is 10% and your income goal is $40,000, do you have the potential for sales of $400,000? • If your total farm sales are $100,000 and your income goal is $40,000, is a 40% margin realistic?

12. Exercise • CSA Sales $35,000 • Poultry Sales $18,000 • Other Sales $ 2,000 • Crop and Livestock Inputs $20,000 • Other Operating Expenses $15,000 • Depreciation Expense $ 5,000 • Interest Expense $ 2,000 • Questions: • What is your profit margin? • If you want to grow your business to make $40,000, what does your sales have to be?

13. Exercise Answers • CSA & Poultry Sales $55,000 (100.0%) • Operating Expenses $35,000 ( 63.6%) • Depreciation Expense $ 5,000 ( 9.1%) • Interest Expense $ 2,000 ( 3.6%) • Net Income $13,000 ( 23.6%) • To make $40,000 (assuming you keep the same net income percentage), you would need approximately $170,000 in sales.

14. Needed Records • Margins also can be calculated at the enterprise level… • If we want to make pricing, product mix, or production change decisions, we need to do that at the enterprise level.

15. Enterprise Budget • An enterprise budget is an estimate of costs and returns to produce a product. • For producers who grow a large number of different products. • Develop budgets for those products that contribute the most to your business goals. • Think of the 80/20 rule – for most businesses 80% of their profits (not revenue) are provided by 20% of their products.

16. Example of 80/20 • Instead, assume you sell 5,000 chickens for $15.00 per chicken for a total of $75,000 in revenue. • You also produce vegetables for a CSA; 60 shares at $350 per share for a total of $21,000 in revenue. • Poultry is approximately 78% of your revenue.

17. Example of 80/20 • Also assume your net profit margin for chickens is $2 per head; $10,000. • Your net profit margin for vegetables is $7,000 per acre (you have one acre). • Poultry is approximately 59% of your net profit margin. As an enterprise, poultry has a net profit margin of 13%.

18. Example of 80/20 • How would you treat the vegetable enterprise (as a secondary or primary enterprise)? • What should you do with the poultry enterprise?

19. Exercise • Assume you want to raise pastured poultry and run a small CSA with a goal of $40,000 income. • Your calculated profit margins are $2 per bird and $7,000 per acre. You max out your labor at 2 acres or $14,000. Questions: • How much profit do you need to make from your poultry enterprise? • How many chickens would you have to sell?

20. Exercise Answers • You would need to make $26,000 from your poultry enterprise ($40,000 - $14,000). • You would need to produce 13,000 chickens to reach poultry sales of $26,000. • Do you have the capacity to produce 13,000 chickens?

21. Enterprise Budget • You can develop enterprise budgets for each major part of your business. • Example, CSA with poultry/livestock. Complete a CSA and livestock budget. • CSA with multiple seasons and use of high tunnels/greenhouses. Complete an enterprise budget for each season (spring, summer, fall) or production system (open ground, high tunnel, greenhouse). • The process is the same for all scale of farming operations.

22. Simplified Enterprise Budget Green Beans (4x100 ft bed) Revenue: 120 lbs @ $3.00/lb $360.00 Crop inputs: (Seed, fertilizer, etc.) 25.00 Labor 180.00 Supplies 4.00 Ownership (machinery, land, irrigation) 11.00 Total production cost $ 220.00 Marketing costs $ 68.00 Profit margin (%) $ 72.00 (20%)

23. Simplified Enterprise Budget Salad Greens (4x100 ft bed) Revenue: 30 lbs @ $5.00/lb $150.00 Crop inputs: (Seed, fertilizer, etc.) 7.00 Labor 28.00 Supplies 1.00 Ownership (machinery, land, irrigation) 11.00 Total production cost $ 47.00 Marketing costs $ 50.00 Profit margin (%) $ 53.00 (35%)

24. Profit Margin Analysis • Let’s say your goal was to have a profit margin of 25%; or $0.25 out of every $1.00 of sales to stay in your business. • Remember profit margin is what is left over to pay for your family living expenses, savings, retirement, and farm growth.

25. Profit Margin Analysis • You determine your profit margin analysis for each of your six major crops and put them in a table (that follows)…these are the six major crops that contribute 80% or more of your whole-farm profit margins.

26. Profit Margin Analysis

27. Profit Margin Analysis • Three (half) of your crops have a profit margin below your goal of 25%; potatoes, snow peas, and specialty green beans. • What do you do to increase their profit margins? • Three (half) of your crops have a profit margin above your goal of 25%; greens, carrots, and heirloom tomatoes. • Do you analyze these as well or are you happy with the numbers?

28. Remember…. • There are two ways to improve profitability…one of them is to increase your profit margin per unit produced. • So you can either reduce your costs to produce and market your product or increase your price. • Let’s first look at reducing your costs…

29. Reducing Cost – Enterprise Budget Use the budgets to calculate break-even prices and yields. For example, cost per lb. of beans sold was $2.40 ($288/120 lbs). Compare this number to other producers or published budgets to determine where costs are different and why.

30. Reducing Cost – Enterprise Budget A second reason – track key costs. Green bean example, $180 (or 82%) of the total production cost is labor. Most of the labor is weeding and harvesting. Question - can labor be lowered without reducing yields (i.e., can labor be more efficient)? Crop inputs is a small percentage (10%) of total production costs, a 10% reduction in costs won’t affect total production costs significantly. Don’t spend time on small items…

31. Pricing • The second way of increasing profit margin per unit sold is increasing the price of the product. • For an individual product, what does it cost to produce and market that product? • If snow peas cost $3.06 per lb. to produce and market, what should the price be (take a minute to calculate)?

32. Pricing • So if your margin goal is 25% and your break-even cost is $3.06 per lb., your sales price would need to be $4.08 per lb. (3.06/.75). • Will your consumers and competition allow this price? If not, what price will they allow and what is your profit margin at that price? If you can’t get to where you want, what do you do?

33. Pricing • Same process regardless of what you are producing… • Example – CSA share cost you $240 per share to produce and market, price it at $320 ($240/.75). • Chickens cost you $2 per lb. to produce and market, price at $2.67 per lb. ($2/.75).

34. Pricing and Marketing Outlets • Pricing – costs need to be known otherwise you are shooting in the dark. Add a desired profit margin to the total cost of producing and marketing product(s). Compare that price to customers’ willingness to pay and competition. • Market outlet – compare outlets that are available. Don’t focus on selling price (gross sales), focus on profit margins.

35. Marketing Costs Gone Wild Two markets per week for 20 weeks. Labor – 2 people, 6 hrs per market per person, $12 per hour. Vehicle – 80 mile roundtrip @ $.50/mile. Supplies and misc - $20 per week. 800 lbs of tomatoes taken to market; 95% sold (760 lbs).

36. Marketing Costs Gone Wild

37. Total Cost Can you average a selling price of $2.55 per lb.?

38. Discussion • What do you do if your major products had an operating profit margin over your goal and yet your whole-farm operating profit margin was under? • Were you consistent in how you accounted for revenue and expense items between your enterprise budgets and whole-farm records? • Are your non-signature products heavily capital or labor-intensive?

39. Discussion – More questions • Are you in the development stage of your business? In other words are you trying to promote a new marketing outlet and/or product that will take time to become profitable? • Are you at the right scale of operation regarding all your products? Do you have a lot of machinery expense for a non-profitable enterprise? If yes, could this be accomplished in another manner.

40. Summary • Improving profitability can occur one of two ways: • Increasing your profit margin per unit while maintaining sales levels • Increasing your sales levels while maintaining your profit margins. • Enterprise budgets can be used to determine current profit margins and determine where they can be improved.

41. Summary • If you are below your profit margin goal, what can you do to make it better? • What are the opportunities for increasing your price – do you have the right customers? • What are the opportunities for changing production practices (to increase production levels or reduce expenses) or product mix?

42. Questions….. Any questions or comments? Thank You for This Opportunity! Craig A. Chase Local Foods Program Manager Marketing and Food Systems Initiative Program Manager Iowa State University 209 Curtiss Hall Iowa State University Ames, IA 50011 (515) 294-1854 cchase@iastate.edu