Budgeting and pricing vital to profits
by Deborah Jeanne Sergeant
Both budgeting and pricing goods determines if a farm business will be profitable. Kelly McAdam and Kenesha Reynolds, University of New Hampshire Extension specialists, presented “Taking a Good Look at Your Enterprises” at the recent New England Women in Livestock Business Winter Virtual Conference.
McAdam said an enterprise budget includes an estimate of returns and all costs associated with the production of a single product or service, expressed on a unit basis. How much does it cost to produce that whole chicken or that quarter of beef? By determining these returns and costs, farmers can better plan and “develop projections for business at different prices and volume production,” she said. They can also better control costs and set target prices and sales to improve marketing.
She said farmers need to ask themselves if they can support the rest of the farm with the prices they charge and see their biggest costs.
“Maybe you’re paying an outrageous amount for a supply you need and you don’t notice when you’re writing checks out,” she said. “Is there an alternative? Set your target prices and sales, not just the cost part of that.”
A budget helps answer questions such as Am I charging enough to cover my costs? What are my biggest expenses? Can I produce enough to be profitable? Can I make enough to contribute to household income? Should I buy that tractor, cow, piece of land, etc.? If I had to make a major change in my business, what impact could that have on my checkbook?
“Make a household budget as a family so you know much this farm contributes to this,” she said. “It’s not just the farm writing you a check. It could be supplying food and other things that contribute to the household.”
Farmers should consider what they would do if they needed to step away from the farm for some reason. Could the farmer afford to do so or hire someone or possibly scale down?
McAdam said farmers need to know their variable costs, gross profit and fixed costs. The mortgage, property tax and insurance are fixed costs. Sales, also called receipts, can include farm sales from farmers markets, online sales and a CSA or sales by product, including whole animals, value-added products and different animals that are raised on the farm.
“When you’re looking at your receipts, your sales, there’s more than one way of looking at that,” McAdam said.
The cost per unit is another important element of determining profits. That depends on how the farm sells its goods, such as by the animal, pound, carton or gallon.
“When you’re selling an animal, are you counting your cost per animal?” McAdam said. “Does it make sense to formulate the costs based upon the hanging weight? Or maybe you have all these cuts of weight and you need your cost per pound as a better way to measure profitability. You could have it by carton for eggs, by the gallon for milk or by the portion for cheese. The bottom line is how are you selling your products?”
Variable costs are directly linked to raising or producing the products and are also called direct costs. The more you produce, the higher the variable costs. Fixed expenses do not change regardless of how much that parcel of land produces.
“Think about property taxes,” McAdam said. “The property I have can support X number of animals. You pay the same amount of property taxes with one animal as a hundred. But suppose you expand your land?”
Some fixed costs are start-up expenses like fencing, buildings, breeding stock and equipment. These major purchases will last, but for costing, it’s important to figure them into the budget to know how much is “used up” in a year because they will eventually need maintenance, repair and replacement. The depreciation is spread over the life of each item.
Labor is a variable expense because the more the farm produces, the greater the labor expenses.
“When we set a budget, we make assumptions,” McAdam said. For example, a two-year budget would allow time for chicks to mature into full-production laying hens. The budget should assume that about 3,900 dozen eggs could be produced from 100 hens in over two years.
“There is a death loss in there,” McAdam said. “You need a mortality rate factored into your budget, like 2% to 4%. Put in replacements that are sold so you’re not necessarily in the business of selling the animal itself, but that is in the budget if this is something you feel you may do in the year.” The numbers can be tweaked.
“Don’t forget to pay yourself. Even if you’re not physically giving yourself cash but you’re hiring a babysitter, you need to build it into the budget,” McAdam said. “Include that number as your wages. Look at this several times per year, but especially before you sell and at the end of your season. Don’t sell your products at a loss.”
Reynolds then said, “If you don’t have numbers and don’t currently raise animals … in terms of cost look at local suppliers’ costs until you have your own numbers,” she said.
Profits also have to do with the cost farmers charge their customers, whether it’s a wholesale client or a direct consumer sale. Reynolds calls the cost “another number vital to your bottom line.” And farmers have different means of arriving at the cost of their goods.
“Cost-based pricing takes into consideration the enterprise budget,” Reynolds said. “There’s the customer piece, the money they have and competitive-based pricing. Who else is selling the products you’re selling?”
Although many different factors can – and should – play into how goods receive a price, Reynolds said it’s far more common for farmers to use only one pricing method. This strategy can cause them to price goods too high or too low. She said that although pricing is complex, time consuming and takes effort, “it is not an afterthought. Don’t raise the animals or produce the value-added items without thinking of the price. You could operate at a loss. Price affects your bottom line. A lot of farmers do it for a passion but the goal of any business is making a profit.”
Reynolds encouraged farmers to estimate their price ceiling and price floor and what they’re willing to accept. They should also evaluate what costs affect price and consider how their mission and values affect prices.
“Keep in mind that your customers almost always are considering prices when purchasing,” Reynolds said.
Knowing the target customer’s age, gender, point of purchase, income level, location and why they buy all factor into the price. In a similar vein, competitor-based pricing requires farmers to know their competition.
“Conduct a SWOT analysis: strengths, weaknesses, opportunities and threats,” Reynolds said. “How can you capitalize on their weaknesses? What are some of the threats they’re facing and how are they handling those threats?”
Stepping up to meet customers’ needs can provide a profitable market share to the farmer willing to carefully examine their pricing.