November 2011 Archive for Ask a Margins Expert

There are some who consider production agriculture to be a gamble. In Vegas, it's common knowledge that cash put into a game does not necessarily mean profit. The vast difference between risking your cash in Vegas versus risking your cash on the farm comes down to one word: calculation. Vegas risk is random, while agricultural risk should be calculated.

There is, however, a common challenge that we all face when comparing Vegas to ag production: the human emotions of greed and fear. Unfortunately, these two emotions have the power to drive decisions with even some of the most intelligent marketers. How can we manage these emotions?

Let's use the 2011 crop production as a working example. Let's also use a margin calculator to determine a number of different options for pricing our 2011 bushels. Once harvest is complete, we have two of the three variables in place which will allow us to determine our profit objective.

Here is an example of a margin opportunity calculator being used to determine profitability with five different pricing options. Plug in your yield and your cost of production for each option. From there, simply plug in five different market price scenarios.

 

Once your numbers are in place, ask yourself: What is my profit objective?

There are other factors to consider as you evaluate your profit potential. Currently, the basis is favorable for selling cash grain, and the overall profit margins are still solid for most farms, even at the $5.50 price range. Spend some time discussing what margins are appropriate in your business with your family, partners, marketing advisers and lenders. Each operation is unique and should have its own individual set of profit objectives. What are your margin goals?

Sitting on your grain with no specific plan is taking a big "Vegas" gamble! Instead, develop a plan to manage risk so you can capitalize on opportunities. Greed and fear will always loom as part of our emotions, so be sure to develop a calculated plan to ensure profitability! Don’t allow your luck to be random.

      Know when it's time to – Cash in Your Chips!

If you'd like a copy of the above spreadsheet to calculate your profit margins, just send me a request. The spreadsheet can be used for basically any cash grain crop. Also, feel free to send me your specific questions on managing risk during these volatile times.

 

As we approach year end, many farmers are making purchase decisions for new equipment. One of the biggest drivers for decision-making is often tied to tax planning and the need to spend money in order to limit tax consequences. There are some obvious advantages in utilizing capital purchases as part of tax planning; however, be sure to consider the fundamental reasons for any equipment replacement.

Ask yourself: What is the fundamental reason for the purchase? What are the benefits of this equipment to my operation? How will this equipment improve my efficiency, productivity, and profitability? How will this capital purchase affect my cash flow?

As your farming operation grows larger it becomes increasingly important to analyze equipment purchases. We all have numerous pieces of equipment or tools which need to be replaced. Often it’s clear on what equipment needs to be replaced, but generally the problem for most of us is that we have limited capital resources. With limited capital it's even more important to prioritize, plan, and analyze each replacement item on its own merit.

To help you work through your capital purchases I've included a Capital Acquisition Questionnaire. I received this tool from a business partner who was a company owner in another industry. This questionnaire is designed to help prioritize and justify a purchase decision. Another benefit is that it illustrates to the suppliers your seriousness in understanding the value of this purchase.

Here is an example of the questionnaire:

 

 

 

1.)     Describe the item and the reasons for its acquisition. Attach pictures and manufacturer’s

        literature.

 

 

 

 

2.)     Has the operation of this item been observed in other farms in a working situation

 similar to ours?   Yes         No           if yes, explain in detail the findings, giving name of company               and application.

 

 

 

 

3.)     Have we obtained competitive quotes? If so, detail below:

 

 

 

4.)     Attach a brief description of where the new item would be used.

 

 

5.)     What would be done with the replaced item?

 

 

 

6.)     Is there a local service representative? If yes, who? If not, where is the closest one and

         who is it? Is the representative a division of the manufacturer or a contracted agent?

 

 

 

7.)     What are the installation /assembly costs including freight and the displacing of other machines?

 

 

8.)     How much training is required to operate this item? Describe:

 

9.) Could these same operations be purchased or custom hired, and if so, have we obtained

       competitive quotations? Explain:

 

 

 

10.) Has consideration been given to the leasing of machines rather than buying, if the useful   life is short or there is danger of rapid technological obsolescence?

 

 

 

11.) Outline and attach the reasoning behind the purchase with calculated return on investment and payback, if applicable.

 

 

 

14.) Comments:

 

 

 

 

Action              Approved               Denied  

 

 If you'd like a copy of this or have additional questions please let me know.

As harvest nears completion for most everyone, now is a great time to review your harvest performance while things are still fresh in your mind. Think about your operations efficiency, productivity, and profitability. Just as businesses in other industries analyze performance and build action plans to improve and grow their business, it's equally as important we do the same in production agriculture. With the massive amount of capital required to operate our farms, the economic payback for strategic planning generates immediate returns to the bottom line!

This following example outline will demonstrate the process of analyzing efficiency, productivity, and profitability. This is simply a tool to help guide you through the process of documenting your overall performance in order to develop action plans for improvement. This tool also serves as a communication system to encourage everyone in your operation to come up with solutions to challenges. Including input from everyone will tend to produce better solutions, rather than expecting yourself (whoever is in charge of the process) to have all the answers.

As you work through any performance review keep in mind that it's a process to work on over time. Consider breaking the process into three parts. First, brainstorm your ideas and concepts for needed improvements. Second, prioritize your improvement needs and begin to develop a strategy to accomplish them. Third, put together timelines with specific deadlines and the individuals who are responsible for results.

 With a focus on improving efficiency, productivity and profitability you can insure yourself a competitive advantage without necessarily having to do more. Better analysis and planning will always improve your bottom line!! $$

In addition to the obvious cash returns from the mapping, even the basic technology can generate significant margin improvements. It's important to identify what portions of this technology best fit your operation. Take some time to analyze the components you currently use. Ask yourself; “Are there ways to measure the returns from this technology?” If you can’t measure the return, can you justify the expense?

 

Sometimes the simplest pieces of technology can generate the largest returns. For example, some consider auto steer to be more of a “convenience” than a “cash return” component of the technology.

 

Here is a specific study that we did this fall to determine the value of auto steer on a combine with row sensors, (enables the combine to steer itself in corn). With significant wind damage in our area, it was extremely difficult to determine where to drive the combine with no apparent rows to follow. With dust or darkness it was absolutely impossible without auto steer and row sensors!

 

 

As you can see from the above information, fuel cost improvement alone provided in additional $7.75 an acre bottom line savings. There was a productivity improvement of close to 50 acres of additional harvest capacity each day. Not to mention the lower speed also doubles separator hours on the combine, which adds to wear and tear and replacement costs. In our case, we were able to pay for the entire guidance system in one year of use.

 

If you’re using precision equipment, challenge yourself to measure the value. How much is this technology improving your bottom line? Some tools are more valuable than others. Figuring out which components create the most value is a great way to improve your profits.

 

Let me know if you're interested in tools for calculating precision value.