In 2024 and the years that follow, the success of a farm business will have little to do with the farmer's technical expertise in crop production and animal husbandry. It will require farm managers to have the ability to establish efficient business systems and manage a limited pool of risk capital to generate profit.
The F Myth or (Farming Myth) is the myth that great technical ability in production will make for a successful farm business. Yet, in reality, excellent technical ability is only one of many ingredients for farm business success.
The F Myth is a nod to "The E Myth" by Michael Gerber, a top-selling business book published in 1994. (Voted #1 business book by Inc. 500 CEOs). The premise of the E-Myth is The Entrepreneurial Myth
- The myth that most people who start small businesses are entrepreneurs
- The fatal assumption that an individual who understands the technical work of a company can successfully run a business that does that technical work
The F Myth #1: To have a successful farm, you can just focus on high production levels.
Production is a significant driver of agricultural revenue. However, it is over-reliant upon itself as a proxy for profitability. The common thought is that if I just grow more, I will make more money.
The reality is that production is part of a more detailed business equation.
- Yield (Y) x Price (P) = Sales Income (SI)
- Sales Income (SI) – Input Cost (IC) = Gross Profit (GP)
- Gross Profit (GP) - Overheads (OH) – [Interest (I), Tax (T), Depreciation (D)] = Net Profit/Loss (NP/L)
Final Profit equation: (Y x P) - IC = GP - OH - I - D - T = NP/L
Each BOLD part of this business equation is a lever you can pull to change the end goal: PROFIT.
So, the objective measure of a farm business's success is PROFIT.
The best way to think of profit is to think of your business as a crop. You create an ideal condition for it to grow; you monitor, protect, and feed it to ensure it grows to maximise potential yield. Profit is the business equivalent of yield. You use some to "feed yourself", and you use some to invest in the next year of your business. Without profit, your business will need to draw off reserves, have little to invest in for the future, and eventually die.
Production significantly impacts profit, but don't neglect the other core levers in your business for its sake.
Over capitalisation:
It is common for farm businesses to over-capitalise to chase yield and quality. In many cases, over-capitalisation in depreciating assets may have minimal impact on end yield but significantly affect interest paid and depreciation (a genuine and neglected cost). So you may get a 1% yield increase but lose this extra revenue and more in the cost of depreciation and interest.
Ratio to work out: What is your cost of depreciating capital per tonne harvested, litre of milk, kg of meat, or kg of wool? This is an exercise to get an understanding of the impact your capital cost has on your end profit.
This is what the calculation looks like:
Annual depreciation (D) (think of this as the money you have to put aside each year to replace the machine in the future) + Interest (I) on money borrowed or loss of interest on cash not invested + Annual repairs and maintenance (R) + Fuel (or other inputs) (F) / Divide by The total annual production volume (P)
D + I + R + F / P
Marketing neglect:
Income = Yield (Y) x Price (P)
They both have a huge impact on the amount of money received. Do you give them the same amount of your time?
Do you spend as much time reading, researching, planning, doing and monitoring your pricing and marketing strategy as you do on your production research, trials, planning, monitoring and doing? If not, why not?
Gross Profit neglect:
Gross Profit (sometimes referred to as Gross Margin percentage) is Sales Income less direct Input Cost (IC) e.g. seed, fertiliser, chemical, shearing, pest control, feed, etc…
- What is your input cost (IC) to grow that crop per Ha?
- What is your input cost (IC) for growing that Steer or lamb per Head?
- What is your break-even point? Being aware of your break-even point will enable you to make the right decisions, leading to higher gross profit. E.g. What combination of Yield (Y) x Price (P) do you need to break even on your Input Cost (IC)?
- Do extra inputs mean more yield but less Gross Profit?
- Do you make more money growing more? Where does your push for yield start reducing profit and increasing financial and production risk?
Overheads (O) (Fixed Cost)
The difficulty of adjusting overheads to protect profit:
Overheads are very inflexible by nature. These are your standing still costs (you will incur them if you stand still and do nothing). Excessive overheads need to be kept in check, yet are important investments that, if cut, can affect the capacity of the business.
E.g. You could reduce labour costs by doing more of this work yourself. This would lower your overhead but would negatively affect the amount of work that can be done and possibly impact your physical and mental health.
You could cut professional advice and business services, but this saving could cost you a lot more if you make poor business decisions as a result.
As a farm business, yield and quality remain your daily activity's core focus. Yet, your production decisions must be made based on how it will effect your profit and financial risk.
Key points:
- Look carefully at the critical levers to Business Profit
- Focus on the levers that have the most significant influence first
- Protect your margin, not your yield!
- Yield is vanity – Profit is sanity!
Next week, I will discuss F Myth (Part 2): Farm businesses have no control over the risks they face.
