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Prairie Grains is the official publication of
the Minnesota
Association of
Wheat Growers,
North Dakota Grain Growers Association,
South Dakota Wheat, Inc., and the Minnesota Barley Growers Association.

Pratt suggests that a business is a chain of three economic links: overhead, gross margin and turnover (business size). There are three ways to increase profits in any business: decrease overhead costs, increase gross margin per unit or increase turnover (business size). "In fact, these three ways are the only ways to increase profit in any farm or ranch business," says Hughes.

There are three kinds of overhead costs: land, labor, and management, and while economists call these fixed costs that are independent of number of animals and crop acres, these costs can indeed be changed, and reducing overhead is certainly one of the three effective ways to increase profits, says Hughes.

If you want to know where you are making your profits in your farm or ranch business, break it into its profit centers and treat each profit center as a stand alone business. Gross margin is a measure of the economic efficiency in your livestock and cropping profit centers. Gross margin is calculated for each profit center by subtracting the direct costs of production in that profit center from the gross income of that profit center. Gross profit is the sum of all profit centers’ gross margins added together. Profit or loss is determined by subtracting overhead costs from gross profit.

Turnover is a term being used to measure the size of the farm business. The higher the turnover, the larger the business. If gross margin per $1 is positive, then increasing turnover (size) will increase profit—provided that the increased size does not also increase overhead costs.

The key to Pratt’s technique for increasing profit is to study the accompanying illustration. Starting on the left-hand side, profit is calculated by subtracting overhead from gross margin. So if profit is low, it is due to two possible reasons: either gross margin is too low or overhead is too high.

Gross margin is calculated by subtracting direct costs from gross income. If gross income is too low, it is either because of low production or low price. If market price was not high enough it was due to a down market or poor marketing techniques. If gross product is low but price is reasonable, then production is too low.

If gross margin is low but gross product is not the problem, then the focus should turn to direct costs. There are only two major direct costs in beef cows, says Hughes: feed costs and health costs. If direct costs are too high, it is either due to high feed costs or high health costs. If feed costs are too high, it is due to feeding unbalanced rations or high waste. If health costs are too high, it is due to high treatment costs or to the high use of preventive medicines.

If gross margins are healthy and the business still is not profitable, the problem must lie in the overhead cost category. There are only two kinds of overheads in this example—land costs and labor costs (family living draw is considered a labor cost). If overhead costs are too high, either land costs or labor costs are too high. If land costs are too high, it is because land is being acquired that is overpriced compared to its productivity, or the cost of maintaining the existing land is too high. If labor cost is too high, it is either because the family living draw is too high, or equipment costs associated with labor are too high. An example is having a pickup for each employee or having more tractors than drivers.

If gross margins are healthy and there is no room left to cut overheads, then turnover is the most promising way to increase profits.

Hughes says many farmers and ranchers spend most of their management time focusing on fine-tuning items on the far-right hand side of the figure, and that most extension educational programs are also focused on these items. But he believes that changing these far-right items will not save a farm or ranch business in today’s tough times.

Today’s tough times call for tough actions, he says, and if you are serious about putting your farm or ranch back in the black, you need to work on the big items; those on the left side of the illustration. In these troubled times, he suggests that the big payoff is in changing gross margin, reducing overhead and evaluating turnover (size). A well-known national financial consultant suggests that his clients generally have 15% of their overhead that is not really needed. Cutting overhead is where Hughes says he would start for coping with today’s markets and beyond.