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Management decisions – How do I know it will pay?

Jim Gerrish Published on 30 May 2014
Stringing hose

Have you ever heard the saying, “There’s no such thing as a free lunch”? There are not many things around a farm or ranch that come without a cost.

Many of our management decisions revolve around the questions, “What will it cost me?” and “Is it worth it?” We ponder questions like whether to build more fence, whether to develop a spring and pipeline, whether to replace a current pasture with something more productive.

How do you go about deciding whether you should do it or not? Do you approach the question systematically or go by gut feeling?

I don’t have any advice to offer you if you just go by your gut, but we do have processes and tools available to help people who want a systematic approach.

Economists and farm management specialists have used enterprise and partial budgets as decision support tools for decades, if not centuries. Because I’m a spreadsheet geek, I like to have easy-to-use spreadsheets to help me address these questions.

Once I have a basic format, just a little tweaking with a good spreadsheet can answer a lot of different questions.

When you’re pondering the “Is it worth it?” question, what do you really need to know? What it really comes down to is the cost of implementing the change in your business and the expected return from making the change.

We can get a pretty good idea of the added costs for installing a couple miles of stock-water pipeline and several tire tanks. Those are pretty straightforward numbers because there is someone out there willing to sell you products and do the work for you.

The same can be said for reseeding a pasture, building fence or any other practice that involves goods and services.

What about something like changing your calving season or switching to a different type of bull? It is a little more difficult to come up with an estimated cost for making that change.

Now we have to start making some assumptions regarding potential cost savings as well as having to shell out more money for a bull upgrade. There are a lot of ripple effects we might not even think of initially.

But if you do think about it and talk with other people who have done similar things, we can still come up with some reasonable expectations and assumptions.

Any time we make assumptions regarding costs and returns, we always want to overestimate the potential added costs and underestimate any cost savings or increased returns. Better to receive pleasant surprises than bitter disappointments.

building fence

Any projection of future added returns to our enterprise is purely speculative because we don’t really know what tomorrow will bring. We can make reasonable projections based on what happened yesterday or last year, but change is the great constant in life.

All things will change, so we need to be prepared to adjust when they do change. Keeping your projection conservative will provide some protection against the shockingly unexpected changes.

While we’re on the subject of time and the future, another important question is how soon do you want or need this investment to pay off.

If we have our entire lifetime to consider, I can show you that almost any pasture improvement practice will ultimately pay off. The question is: Can your current cash flow situation allow you to shift funds from their current usage into some other pathway?

Generally, I like to see capital improvement projects fully pay for themselves in five years or less. Unfortunately, that doesn’t always work out, and we may need to take a different approach to the project.

Even though we can potentially show a very good return on investment over a 10-year to 20-year horizon, we really have no idea if any of our financial assumptions will be valid through that time period.

The shorter the cost recovery period, the greater the likelihood of things actually working out according to plan.

Another positive aspect of achieving a quick payback on your investment is that any residual benefits occurring after the end of the payback period become almost pure profit.

That is a simplistic view from a non-economist, but my experience is you will have more money in your pocket, and that is close enough to profit for me.

Let’s walk through the process of cost-benefit analysis for a pasture improvement project.

Since we are generally looking at management practices that will allow us to increase livestock carrying capacity and product output, we can look at benefit as increased forage dry matter production or added stock days.

Our comparison starts from our current level of productivity, so it is important to have some idea of what your land is presently producing.

The next step is to project what increase in productivity might be expected from implementing this practice. Talking with producers and grazing professionals who have implemented the same practice is a good starting point.

You will likely hear a range in responses. I like to go with the low end of expectations and see how the financial side looks from a conservative position.

If we consider a fence and stock-water project, our expectations might be for a small response in the first year and then increasing benefit over time as we learn how to use the new infrastructure to help our daily grazing management.

We might project just a 10 percent increase in the first year and then incremental additional increases over the next four years. At the end of year five, maybe we expect to have a 50 percent increase in number of stock days harvested per acre.

We can place a value on each stock day and calculate the increased revenue stream. Custom grazing is the easiest example to use because you are being paid directly for each added unit of production, but you can calculate a stock-day value for any class of livestock.

Once we have the response charted, we can start looking at the added or reduced costs resulting from our project. If we have developed a budget plan for the project (a must), we know what implementing the practice is going to cost us over time.

It is important to include additional repair and maintenance costs that will be incurred over time as well as added labor into our calculations.

If you build 10 miles more fence and install a pump, pipelines and tanks, there will be additional annual operating costs that you didn’t have before. If it were a pasture-reseeding project, you may have increased fertilizer requirements for future years.

From the difference between the added costs and expected returns, we can calculate the lifetime return on investment for the practice. Hopefully, it is positive and we are glad we made the change.

If it is negative, we should be very happy we went through this planning exercise before tearing up our existing pastures and re-seeding to some wonder grass that only lasted a few years.

Remember: No one plans to fail, but many fail to plan.  FG

PHOTO 1: Investing in a stock-water project may increase the number of grazing days, adding value to your operation.

PHOTO 2: A fencing project may increase production and profit in the short term but may stretch cashflow, and profits must be adjusted by future repair and maintenance costs. Photos courtesy of Jim Gerrish.

Jim Gerrish

Jim Gerrish
American GrazingLands Services LLC