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Get good before you get big

Ben Eborn for Progressive Forage Published on 06 January 2020

Starting and growing a business is part of the American dream. Farm and ranch business expansion is often motivated by the need to increase profitability and improve production efficiency. Businesses experience growing pains just as teenagers do. Growth tends to magnify the weaknesses in a business. Setting things in order when your business is small is much wiser than waiting until you have a big business and a mess to clean up. Here are four things you can do to improve the profitability of your business as it grows.

1. Set up a good financial system

Make sure you have a good financial and accounting system in place. When your business is small, you might get by with keeping track of finances and cashflow in your head. But as your business grows, keeping track of financials in your head can be tough – and dangerous.

If finance isn’t your strength, consider delegating this responsibility to a family member or outsourcing it to a bookkeeper. Do this to improve the profitability of your management decisions, not just because your banker requires it. A good financial system will, at a minimum, include the following:

  • Annual balance sheet to track assets, liabilities and, most importantly, net worth
  • Annual income statement to track profitability and assist with tax management
  • Monthly cashflow budget and actual in-flows and out-flows comparison
  • Annual financial analysis including measurements of liquidity, solvency, profitability, repayment capacity and financial efficiency

The best managers also do enterprise accounting. This is breaking the whole business down into enterprise units then budgeting and tracking costs at the enterprise level. This degree of management is where profit is made. Not many managers keep financial information at this level, but the most profitable managers do.

2. Generate a positive gross margin

Gross margin is the net returns above production costs, or in other words, the difference between total revenue and production costs. It’s a measure of how efficiently resources are used to generate profit. Gross margin is the main key to growing a profitable business.

A positive gross margin means your business may be ready for expansion. The bigger your business, the more profitable you will be. The opposite is also true; if gross margin is low and you’re not able to cover overhead costs, growth will kill your business. The bigger you get, the more money you will lose.

Managing to improve gross margin can be more profitable than expansion. There’s no silver bullet for improving gross margin. The two strategies are simple – but not easy: either increase revenue or decrease production costs, or a combination of the two. That’s the never-ending challenge for all business managers.

3. Build strong marketing skills

In the past, farmers and ranchers focused on production; marketing was secondary. Circumstances have changed. Prices are much more volatile today than they were 20 years ago. It’s still important to maintain good production, but marketing what you produce needs to be a primary focus.

A good marketing program begins with knowing your cost of production at two levels.

  1. Break-even price to cover operating expenses
  2. Break-even price to cover total costs (operating and overhead)

Knowing your break-even prices will help you know what a good price is so you can establish target prices. This will take some of the emotion out of marketing. Remember: Fear blinds us to opportunity, and greed blinds us to danger.

Timing is extremely important with the increased volatility of markets. An active marketer will study the markets a little each day. The more time you spend marketing, the stronger your skills will become. Know when to pull the trigger. Know and understand economic price cycles including short-term seasonal price cycles and long-term commodity-specific price cycles. The most profitable managers in the future will be good marketers.

4. Eliminate mistakes

Not doing the wrong thing is just as important as doing the right thing. Many good farmers and ranchers have gone out of business because of simple mistakes.

  • Don’t take unnecessary risks.
  • Don’t buy in at the top of the market.
  • Don’t borrow the maximum amount of money the bank will lend you.
  • Don’t partner with someone who has a questionable reputation.
  • Don’t settle for a handshake lease agreement.
  • Don’t let your farm liability insurance expire.

The list goes on forever. The best managers strive to eliminate mistakes.

Of course, every business owner makes mistakes now and then. It’s best to make mistakes on a small scale, and then learn from the experience. It’s often easier to recover from a mistake or bad decision when a business is young, small and nimble. Learn from those mistakes, survive and come out stronger. Will Rogers said it best: “Good judgment comes from experience, and a lot of that comes from bad judgment.” However, it’s much better to gain experience by learning from the mistakes of others. We don’t have to be “hands-on learners” when it comes to making mistakes.

Growing a farm or ranch business can be a rewarding challenge. Building your business on a solid foundation with a good financial system, a positive gross margin, and a strong marketing program will lead to success. Learn from the mistakes you make, but try not to make them in the first place.  end mark

Ben Eborn
  • Ben Eborn

  • Extension Economist
  • University of Idaho
  • Email Ben Eborn