Using your profit drivers to generate more profit

Maximising farm profit is one of the key goals for most businesses. But understanding how to do this, and what drives profit, isn’t always clear.

Over the next couple of months, I’ll be sharing a series of blogs to help you:

• Understand your profit and your profit drivers
• Manage prices and production to drive profit
• Manage costs to drive profit

Defining profit

In simple terms, profit is the income you have left over after you’ve paid all costs. It’s calculated as:

Net profit = Gross Farm Income –Costs

Now, to calculate this, you need to know your gross farm income. We sometimes refer to this as total revenue or gross farm receipts. To work it out, include all farm income from commodity sales, contracting and any other revenue produced by the farm. Don’t include grants, insurance recovery or sales of assets.

The costs of producing your product and running your farm or agribusiness include:

• fixed and variable operating costs
• allowances to replace livestock, plant and machinery (which may include depreciation)
• finance costs (interest, lease costs)
• management allowances (if you don’t get paid a salary)
• taxation

Understanding profit drivers

Profit drivers are internal and external factors directly influencing your farm’s profitability. You can break them into revenue drivers and cost drivers.

Revenue drivers are the factors that increase your farm’s income, such as:

• increasing crop yields by improving water use efficiency (WUE) and soil management 
• changing or diversifying your crops or livestock
• improving the quality of your product and therefore commanding a higher price
• finding new markets for your products

By focusing on revenue drivers, you can increase your farm profits even if your costs remain the same.

Cost drivers include fixed and variable costs. So, by reducing them, you can increase profit.

This could include:

• reducing waste
• using efficient production methods
• negotiating more competitive prices for inputs
• managing the use of inputs such as seeds, fertiliser or fuel

Profit drivers affect farms differently depending on market conditions, farm size and location. They can also vary on a single farm from year to year.

Information is power – and profit

If you understand the drivers of profit on your farm, you can make better decisions about production, investments and expenditure each season.

For many farms and agribusinesses, technology has made a big impact. This is the case with both understanding profit drivers and making changes. If you’re an early adopter of technology, this head start will often lead to even better profits as you see greater returns with fewer inputs.

But relying on the latest technology is not enough. Staying up to date with current events, regulation changes and developments in your sector will also help you make better decisions.

More than just cutting costs

Now you understand the drivers of profit, it’s probably clear why cutting costs is not a magic bullet to increase your profit. In fact, by focusing on cutting costs, you’re taking a short-term view that may cost you more in the end.

As the example below shows, increasing revenue is likely to have a more positive impact, as it has a multiplying effect. So, while it’s easy to get stuck focusing on costs, the proper focus should be on maximising profits.

Example

To illustrate how profit drivers work, we’ll start by looking at what happens when you make $100.

$30             variable costs – increase or decrease depending on how much you produce eg: labour, seed, fertiliser

$30             fixed costs/overheads – pay the same no matter how much you produce

                        eg: plant, equipment, repairs, rates.

$40             Profit

As I noted above, for many farm businesses, reducing costs is the default approach when they want to increase profit

So, in this example, you still make $100, but you focus on reducing costs.

$30        variable costs stay the same

$27  reducing fixed costs/overheads by 10%

 $43        Profit

But what if you instead focused on increasing revenue by 10%?

You now make $110

$33      variable costs have also increased by 10%

$30      fixed costs are the same

$47      Profit

By increasing production and revenue, you’ve been able to increase profit more than if you simply cut costs.

On $100, this might not seem a lot. But when you’re talking hundreds of thousands or millions of dollars, it makes an enormous difference.

Client story

Even I initially thought that reducing costs was the way to make more profit. I’ve built a business around reducing agribusiness costs such as bank fees and interest to increase the profitability of the businesses I work with.

But, over time, I’ve recognised that the most effective way to increase profits is not to just focus on reducing costs and also to increase revenue.

I have clients that run sheep on the non-arable parts of their farm. It’s a secondary income to the farm and they haven’t paid a lot of attention to the profitability of the enterprise, instead concentrating on the cropping.

The upcoming generation is interested in the livestock side of the business. They’ve started looking at opportunities to improve the management of the sheep enterprise. After drawing up a budget, they got professional advice so they could make informed decisions about improving the livestock enterprise. With some improvements to pasture, paddock size and genetics, and a review of markets for their livestock, they’ve established a very profitable secondary enterprise for their business.

Maximising income from the livestock enterprise will assist with increasing profit. Combining this with monitoring and reducing costs, my clients are looking forward to a strong future in agriculture.   

Conclusion

When was the last time you examined the internal and external factors influencing the profitability of your farm or agribusiness?

Next month, my blog will look at how you can manage prices and production to drive profit. But in the meantime, if you have any questions, please get in touch.

Over to you

If you liked this article, I’d love you to share it. And if you’ve got any comments or questions, please get in touch.

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