Put Your Livestock Operation on the Path to Profitability
Learning to use a gross-margin analysis was the biggest breakthrough in Steve Kenyon’s ranching career. It brought him back from the brink of economic disaster and set his business on the path to profitability.
Before discovering the economic tool, it was becoming increasingly apparent to Kenyon that his successful production practices were not enough to swing the economic pendulum toward profitability.
“I was good at grazing, and I had excellent results with reproductive rates,” he says. “My winter feeding was very cheap, and I had very low death rates. I was working long hours and bringing in a good wage from off the farm. Buy why was I failing? Why were we broke?”
After learning to use a gross-margin analysis at a Ranching for Profit school in 2001, Kenyon put his cow-calf and custom-grazing enterprises under the microscope. He analyzed each as separate profit centers. Kenyon found that the cow/calf enterprise couldn’t support the high cost he incurred for grass. Custom grazing fared better.
Today, Kenyon and his wife, Amber, center their ranching operation around custom grazing near Busby, Alberta. Their business – Greener Pastures Ranching Ltd. – leases 3,300 acres of grassland from 22 landowners. They custom-manage 140 beef cows year-round and custom-graze 800 yearlings during the growing season.
Additional enterprises include small holdings of feeder cattle and pastured hogs for direct marketing of grass-fed beef and pork.
building a budget
Before taking on an enterprise comprising a profit center, he budgets for all costs. In the budgeting process, Kenyon pays himself a wage and covers equipment expense as well as depreciation, inflation, and opportunity costs. If the economic analysis shows that the revenue is not enough to cover all costs and still leave a 50% gross-margin profit ratio, he’s cautious about taking on the new enterprise.
With agriculture’s net returns often hovering at only about 2%, Kenyon’s high expectations and structured budgeting process have put him in demand as a speaker and seminar instructor.
“The gross-margin analysis is a powerful tool that allows me to dissect my business and to find out where it is profitable and where it is not,” he says. “By breaking my operation into profit centers, I am able to see which production practices are working and which ones need to be improved or eliminated.”
Kenyon defines a profit center as simply one component of a business. “Many profit centers may make up a farm,” he says. “A farm could have a cow/calf profit center, a feeder profit center, a hay profit center, a grazing profit center, or a grain profit center.”
When figuring the profitability of a profit center, Kenyon charges market value for inputs consumed in one profit center but produced in another. For instance, the market value of hay consumed by cows is charged to them as an expense and credited as income to the hay profit center.
When a profit center is operating in the black, the gross income minus the direct costs associated with that profit center yield a positive gross margin. This contributes to the total contribution margin, which must then cover all business overhead costs. These comprise all costs not associated directly with individual profit centers and include the noncash costs of inflation, depreciation, and opportunity cost.
“Opportunity cost is a measure of your management,” he says. “Are you getting enough of a return on the assets that you are managing? Or should that investment be somewhere else? You might look at it as an interest charge on that investment. An easy way to determine your opportunity cost is to use the highest interest rate you are currently paying on borrowed money. I like to use an opportunity cost of 10%.”
When a profit center consistently loses money, an obvious solution is to drop the enterprise. But personal goals are, of course, critical drivers of enterprise choices. While Kenyon has chosen not to own cows because of their high opportunity cost and low profit margin relative to his environment, he consults with cow/calf operators seeking ways to reduce production costs.
Calculating a yardage rate for overwintering cows pinpoints feed costs. One client had a per-cow yardage rate of $2.30 per day. The high rate included hay, labor, and equipment for a feeding system requiring the hauling and processing of hay in a concentrated area.
“We dropped it to 30¢ per head per day just by bale-grazing in a more extensive area,” says Kenyon. “While managing a cowherd in my own operation, I sometimes get my actual yardage rate down to 15¢ per head per day, but I still charge the cattle 45¢ a day. That’s when I make the most profit.”
Enhanced soil fertility is a hidden benefit from bale-grazing cattle over winter. Kenyon has found that his overall gross margin is highest when he maintains a cowherd over winter. By rotating the areas where he bale-grazes the cows, he is, in time, able to increase soil fertility over a broad area. These fertilized areas produce more forage in the growing season, providing more feed for the custom grazing of yearlings.
Calculating profitability margins for each enterprise has, so far, given Kenyon the economic cushion to withstand unexpected adversity. “Because I budget for all potential costs beforehand and pencil in a 50% gross-margin ratio, I still get paid even if, in the end, I do have a wreck somewhere along the line,” he says.
figuring for the future
By including inflation, depreciation, and opportunity costs in a gross-margin analysis, you can determine what Steve Kenyon calls the repeatability of profitability for a given enterprise or a whole farm or ranch operation.
The budgeting process ensures that funds are available for the replacement of equipment, for instance, or cows.
On a broader scale, repeatability shows the feasibility of a successor’s purchase of an existing operation.
“This is a big problem for family farms,” says Kenyon. “Dad owns
the farm, and the son is going to get a loan to buy it from him. The son plans to operate the same way as his father, which has been working financially for the father. But the son can’t do it because net profit is not enough to cover his added costs for interest and principal payments.”
Running a full gross-margin analysis – including opportunity costs – may show whether or not the father’s level of profitability provides for a repeatable level of profitability after the operation is transferred to the son.