4 key numbers you need to know...
No, I'm not talking phone numbers (although those can be pretty useful), I'm talking business numbers.
Here are the 4 key numbers that you need to know in your farm business:
Cost of production
In a world of constantly changing input costs, it's vital you know your cost of production. Per litre, kg, or ton, your cost of production will be a key driver in your business profitability.
Cost of production includes all the direct and indirect costs that are required to produce a unit of a particular product. These include:
- Raw materials
- Labour
- Storage
- Utility costs
Dairy farmers will know better than most about the importance of knowing your cost of production!
Gross and net profit margin
Put simply, are you making any money?
Gross margin is one of the key performance indicators of any business. Gross margin tells you the amount of money your business earns from the sale of the product/service BEFORE the deduction of any selling and admin costs.
Put simply:
Gross margin = sale price - CoGS
Where 'CoGS = cost of goods sold' or in other words, your cost of production (see above)
Unfortunately, gross margin doesn't take into account all the costs of doing business. To work out your net margin (i.e. what money is yours to keep!) you need to subtract all the additional business expenses including:
- Operational expenses
- Distribution
- Debt payments such as interest
- Taxes
Once you've done this - and let's hope it's a positive number - then this is your raw, hard cash to keep and do with what you want. You can spend or reinvest it - I'd recommend the later!
Cash Position
You won't need any fancy formulas or ratios for this once - just access to your bank account!
Your cash position is simply the amount of cash you have on hand at a specific point in time.
This is particularly important as farming is a seasonal business. Income tends to come in chunks at different times of the year. Knowing what you have on hand coupled with what money is due to come in and out over the next week, month or quarter is vital for your business.
From these three numbers you can work out if you have enough cash on hand to cover future expenses. If you don't then you need to know how your going to finance it - which is a story for another day!
Expenses & Overheads
For much of the time in farming, you're unable to control the sale price of the produce. You can however control the money flowing out of the business on expenses and overheads.
My advice is to focus here, on what you can control. Barter, haggle and trade suppliers off like your life depends on it. Focus on key areas such as:
- Feeding
- Utilities
- Fertilizer
- Fuel
- Financing supplier
Small improvements in expenses and overheads can make a big different to profitability over the course of a year.
Resources
My go to resource for everything finance and for more on the above is Investopedia. There is literally nothing you won't be able to find out on there.
Or of you want to do some extra reading then I'd recommend reading Financial Intelligence for Entrepreneurs. This is the no bull-shit guide to business finance for none finance people. Basically it explains thing in simple, easy to understand terms.
Until next week.....