The financial practices of successful operations in this environment of compressed margins offer important insights to improving profitability. Below are the financial practices we consistently find among profitable producers.
Enterprise-Level Analysis – Understanding your cost of production of, say, corn versus soybeans, provides valuable information for rotation decisions. But more important to your profitability is applying production cost by commodity to your marketing decisions. Enterprise-level analysis also aids decisions regarding the expansion or contraction of individual enterprises.
Cost of Production – In today’s tight margin environment, many producers are making adjustments to enhance profitability. Without a clear understanding of your variable costs, fixed costs and family living demands on the cash flow, the impact of contemplated changes can’t be accurately assessed. When you know all the costs that need to be covered by income from your operation, you are better able to make constructive management decisions.
Input Cost Optimization – Adjustments to variable costs – particularly the input costs for a specific commodity – are too often executed as a one-sided, cost-reduction process. Producers who optimize costs project how decreasing or increasing an input will impact income. For example, increasing fertilizer expense by $40 an acre to achieve an increase of $60 in income is a good investment. But a $60 an acre decrease in fertilizer would be the wrong cost adjustment if it cuts income by $75 an acre. The right cost reductions increase rather than decrease income.
Fixed Costs versus Variable Costs – Once their variable costs are optimized to achieve the highest return per acre (gross margin), successful producers assess their operation’s ability to pay for the costs of fixed assets (land and equipment). If the gross margin doesn’t cover the cost of fixed assets, the operation needs to either add a source of income or reduce fixed asset expenses by negotiating lower cash rents, restructuring debt or selling assets to deleverage. Each operation needs to calculate and understand its fixed and variable cost structure to determine the level of debt payments or cash rent it can afford.
Defined Marketing Strategy – Successful marketers start by assessing their full cost of production, including fixed, variable and living expenses, for each enterprise. Only then can they project a true breakeven and identify the trigger prices for sales of each commodity.
Having a written plan with target prices based on true breakevens enables producers to maintain the appropriate discipline when the market provides sales opportunities. Plans can and should be modified throughout the year based on changes and additional insights.
Willingness to Adjust – Today’s tight margins create the need for many operations to make changes that include but are not limited to: reducing machinery and equipment investments, negotiating lower cash rents or eliminating high cash rent land, reducing living expenses or deleveraging the operation through the sale of non-income-generating assets or lower-return assets, such as land or excess equipment.
Producers who are willing to make significant and impactful changes, no matter how difficult, have reduced their cost of production, enhanced liquidity and reduced their debt load. They are the ones who are positioned for long-term viability and success. Operations that haven’t made significant changes and continue to lose money are jeopardizing their future.
