Whilst income and expenses make the headline with farm profit – how much impact do these (un-)usual suspects make?
Profit has many guises in business.
It’s important as farm owners to understand the implications of the various definitions of profit.
Also, to understand other influential factors affecting profit.
Why so much talk about profit and farms anyway?
It’s all about retention.
In other words…what you keep after all you’re busy-ness is done.
In business, retention equals profit.
You spend in investment today in order to gain tomorrow.
And after all is weighed and measured, the question remains…have you retained (kept) anything overall?
Or, perhaps you lost out?
The purpose of owning or starting up a farm business is to provide income to pay your personal expenses.
Where your business falls short, your personal upkeep is exposed.
Keeping a close eye on profit, gives you the advantage of minding your personal finances carefully.
A quick glossary on profit
Again, a reminder that a critical feature/characteristic of profit is the period of trade over which it is calculated.
Commonly, month…quarter…year.
This is a note to have in mind as we talk through the definitions of profit below.
Common definitions of profit
- Gross profit = total sales revenue – direct costs of sales (costs directly arriving from selling your produce)
- …tells you if and how much you retain from sales revenue after subtracting the direct costs of making the product and getting it to the customer
- Operating profit = gross profit – overhead costs of running your farm business
- …tells you how much you retain after paying out on routine business upkeep
- Ebit = Ebit – depreciation and amortization
- …tells you how much you retain after taking into account (setting aside) money required to replace capital asset equipment used for operation
…a Smallholdings For Sale definition
Take the following infographic by Zlogg, cloud accounting provider, as a neat intro into understanding the factors directly contributing to farm profit:
This quick round-up of farm business profit is purposed to give you an appreciation of the main faces supporting the theme.
Factors affecting your farm profit
Whilst the points above are direct contributors to the profit/loss position of your farm, there are also other factors which influence the theme.
These influencers of real business profit may not be the most obvious line-up.
But in the long run they will ultimately affect the sustainability of your agribusiness.
Recurring, contracted costs
Contracted costs are outgoings that are set today against earnings tomorrow.
Whilst earnings for tomorrow are yet to be realised, there is the commitment already given to pay out in such cases – regardless of the outcome.
The pressure is always on in business to maintain and also increase sales revenue expectations.
But where there is contracted cost exposure outlasting the immediate needs, the pressure is greater.
If your contractual business obligations mount up, then effectually with every pen stroke in making such agreements you are eroding future profit flexibility.
Chances are, your business will still have expenses anyway.
This is just a function of being in trade.
However, giving yourself the flexibility to amend your future cost structure is a protective measure of sorts against the erosion of profit.
However, as with most business decisions, there is a trade-off to consider.
Many suppliers, for example, will offer price discounts for contracted arrangements or long term tie-ins.
Weigh up your position for the years to come and consider the potential outcomes if expected profit takes a down turn.
What are your contingencies if revenue retention does not quite make the mark?
Threshold arrangements
With some commercial arrangements where you are a customer (client side), there may be activity level thresholds attached.
For example, with some email marketing providers – the fee you pay them is proportional to number of contacts stored in the database, or mailshots sent out per month.
Where the tier of payment you are assigned to has a maximum activity level applied – as a ceiling, a breach of this ceiling will automatically increase your contractually obligated cost.
This might be a permanent (or irreversible) upgrade, or otherwise reversible.
Either way, in order to keep control of your profitability, you’ll have to account for potential threshold breaches within your budgetary planning.
Debt (repayment)
Debt is one sure way to destroy your farm profits.
It offers an artificial burst once the deal is done, but the hangover of repayments has often been known to really put farm businesses under.
Whilst it’s easy to get involved with credit arrangements and accumulate debt, it’s not so easy to get out.
The more debt you carry the greater the liability your farm business carries.
The more of your operational profits, which you thought were yours, are actually owned by your lender.
Bankruptcy and debt liability are heavily allied.
Debt is deceptive.
Grow organically organic.
Invoice payment periods
Invoicing for delivery of goods and services is one thing.
But receiving payment is another.
Bargaining power goes a long way to determining payment scheduling.
Where suppliers perceive they have the advantage, they tend to seek to have payment for delivery either in advance or on receipt – in full.
Where buyers perceive they have the advantage, they tend to delay payment of goods/services until a time after the enjoyment.
As a farm producer, you will want paying sooner rather than later to off-set your costs earlier.
Some larger buyers, may not agree to give you their business without you agreeing to their terms absolutely.
These will often involve a 30-day invoicing period.
If you, however, seek the 30-day period to be amended in favour of a shorter lead time to payment, you might find larger buyers to be more resistant to negotiation.
This can adversely affect your cash flow.
The more delays in incoming cash flows into your business, then the long term profitability and sustainability is hindered.
Consider your customer mix and how it will affect your financial strength, prior to making arrangements.
Consistent supplier arrangements
The more consistent your supplier relationships, the more value they will be for both you and your counterpart.
The longer they have done business with you, the more favourable terms they will tend to offer you to retain your business.
Business will know how much of an additional cost finding new business is.
Also, how unreliable new arrangements are and therefore how prone they are to failure.
On this basis, suppliers who have sold to you for relatively long periods will be more negotiable regarding rates or terms.
Where you are able to arrange lower rates as reward for long term custom, this increases your business profit.
Pipeline investment
Customer base attrition is a reality in any business.
Customers come and customers go – customers vote with their feet (…hopefully in your favour, more often than not.)
Where customers are lost, it is largely reported the cost of recruiting new business greatly outweighs keeping existing business.
Where your customer retention can be improved, it may pay off in the long run to invest in increasing these figures.
Also, in staving off the inevitable fall off, it would be worthwhile investing in a productive sales pipeline.
One that grinds out a predictable influx of sales leads and offers a shortlist of interested newbies should you lose customer contact.
This way you avoid the major expense of seeking new business from scratch, without any preparation.
Another profit booster.
Repeat sales
As we mentioned in the previous chapter, it costs more to attract new business than to keep the business you already have.
Marketing sensibility teaches that encouraging existing customers to buy repeatedly and more often is generally more profitable than getting new business.
There is good reason to this.
Marketing campaigns cost. Often they cost much more than having a conversation with an existing customer.
Mainly because finding a prospective customer who is keen to listen and trusts you enough to buy – much like an existing customer – takes a lot of diggin’ around.
It takes some battling.
This is both time and budget intensive.
Invest today in encouraging upsell/cross sell opportunities among current customers and bolster your future profits.
Direct marketing
Getting your products directly into the hands of your customers, without a middleman saves you on paying out their fee (commission).
Paying a commission for sales, no matter how small, all adds up in the long run.
Establishing direct marketing methods for bypassing the need to pay a facilitator immediately increases your gross profit.
Invest in a direct farm marketing system to protect your profits of tomorrow.
Depreciation
Farm equipment, no matter how low or high tech, unavoidably undergoes wear and tear.
When the damage impairs functionality, the occasion calls for a replacement or repair.
This comes out of your business bottom line.
Don’t forsake your duty to keep your equipment going and in good condition.
It’s better to make provision for this rather than to be caught short at a time of lack.
The round up…
It’s naive to think that profit in business terms related only to revenue minus direct costs of sale.
Aside from overheads in addition to direct costs of sale, there are indirect costs also which are real factors that if ignored can trip up your financial farm management.
Keep abreast of all the actual costs of business, remaining savvy to the factors which can erode your sustainability.
Profit isn’t something which looks after itself.
It requires stewardship.
Stay ahead. Keep afloat.
Do you have any tips on maintaining better farm business profits?
Comment below.