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Ask a Margins Expert

RSS By: Chris Barron

Chris BarronHave a margins question? Through this blog, you will gain insight into improving your bottom line, as a margins expert answers questions and provides farm business advice.

 

"Stress Test" Your Margins

Jan 24, 2012

 

When we think of a stress test, most of us visualize ourselves running on a treadmill in a hospital setting. Doctors perform this test in order to determine the amount of stress that your heart can tolerate before developing abnormal rhythm or to see if there's a shortage of blood to the heart muscle. Information produced from this stress test allows doctors to diagnose potential problems within a person's cardiovascular system. The value delivered from this test can be a lifesaver.
Incredible value can also be achieved through stress testing your business margins in much the same way. Analyzing different stress conditions such as an increase cost of production, limited marketing price opportunities, or decreased yield levels will allow you to determine the amount of stress your profit margin will be able to tolerate. Your business ultimately relies on cash in much the same way your body relies on blood. Determining what it will take in order to keep the cash flow moving is imperative when making production, marketing and risk management decisions.
Stress testing your margin is not a difficult process. As I've discussed before in previous blogs, the three variables that need to be stress tested include yield, cost of production, and market price. Here is a tool for analyzing various scenarios. Simply manipulate the variables "one at a time" into levels that would be stressful for your operation. This will give you immediate insight to the impact on your margin.

 

 
 
 
 
 
Stress Test Tool
 
 
Margin Analysis
 
 
 
 
 
Acres
1000
 
Total Production
175,000
Yield
175
 
Total Expenses
$845,000.00
Price
$5.75
 
Total Income
$1,006,250.00
Cost of Prod. Per/ac.
$845.00
 
Expense Per / ac.
$845.00
 
 
 
Income Per / ac.
$1,006.25
 
 
 
Total Net Income
$161,250.00
 
 
 
Net Income / ac.
$161.25
 
 
 
 
 
 
ROI / Margin
19.1%
 

 

 There is significant value in understanding how margins are influenced by the changes in grain prices, rather than worrying about price alone. The same thing holds true for inputs and yields. You can’t just worry about one of these three variables independently without taking into account the condition of the others.
Your heart needs a normal rhythm and adequate blood flow. Likewise, your business needs a normal rhythm of cash flow, adequate working capital, and a risk management plan in place to help absorb any shortage in price or production.
Proper diagnostic equipment for analyzing your situation is essential to come up with the proper diagnosis and eventually the best remedies for successful decisions. The value delivered from this test could be a lifesaver to your bottom line.
If you're interested in discussing tools for stress testing your operation feel free to send me your questions.
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