Last week, we talked about where most farm owners go wrong in trying to grow their profit.
Most people focus on reducing costs (through things like minimising tax) when what they really should be focusing on…
Is increasing revenue.
As this study from the Wimmera region of Australia shows…
The top 20% most profitable farms spend a bit more than average (blue bars)…but they make significantly more in income (black line).
Put another way, they’re putting in slightly more input for significantly more output.
Inputs are what you put into your farming operation: time, effort, and resources.
Outputs are what you get out: the quantity and quality of what you produce and sell (whether that’s grain, sheep, etc.)
The simple recipe for growing your profits? Keep your inputs as low as possible while maximising your outputs.
Today, let’s dig deeper into this topic and explore the 4 best ways to do this.
Specifically, we’ll focus on a key financial figure called your Gross Margin.
Don’t worry if you don’t know what that means! We’ll tell you what it is and how to calculate it in a minute.
There are 4 simple ways to increase your Gross Margin and we’ll walk through each one, giving you a clear example so you can see exactly how this might play out in your farming business to grow your profits.
FYI: This lesson is pulled directly from our Farm Financial Framework course, where farm owners learn the language of finance to increase profits and build a more sustainable business.
The info was too good to keep it just for our members — we wanted to give you a sneak peek inside the course!
Quick finance lesson: What is Gross Margin?
Gross Margin is one way to measure business performance.
In simple terms, it’s the amount of revenue that’s left over after you account for the Variable Costs incurred to produce that revenue.
Variable (or Direct) Costs are the costs that go up and down, depending on your level of output.
A few examples of Variable Costs in a sheep enterprise are:
- Ear tags
- Supplementary feeding
…You get the drift.
All of the above will vary based on the size of the sheep enterprise.
Another type of cost you may hear us talk about is Fixed (or Overhead) Costs. These are not dependent on the size of the business or production levels. They are costs you incur regardless.
An example of Fixed Costs are your council rates. It’s the same whether you run 1,000 sheep or 10,000 sheep on the same area.
…But you don’t need to worry about Fixed Costs for today’s lesson. We’re just sharing that for your information!
Here’s how to calculate Gross Margin:
Gross Margin = Revenue – Variable Costs
Your goal as the farm owner is to optimise Gross Margin for each enterprise, to the point where profit is maximised. You do that by maximising the outputs while minimising the inputs.
There are 4 main ways to do this and EVERY farm can apply these lessons. Let’s dig into each one now:
Strategy #1: Optimise Investment
The first way to increase your Gross Margins is by optimising your Investment — tweaking things to make the time, money, and/or resources (the investments) you put into the business create even more revenue.
To do this, you’ll add in a bit more inputs to create a large amount of extra output.
Put another way: What’s something you can add to your operation (that costs only a bit of time and/or money) that will produce a BIG growth in revenue?
Example of Optimising Investment: Culling on performance in a Merino wool flock.
If you start measuring the fleeceweight and fibre diameter of your Merino flock, you could then select them based on their measured performance, which would result in a big increase in outputs.
By spending a little more money on the cost of measurement and a little bit of time on measuring (both of these are investments), it can produce a significant increase in your income by keeping only the best performing animals.
That’s the idea behind optimising Investment: investing slightly more inputs to create significantly greater outputs.
Strategy #2: Optimise Efficiency
The next way to increase your Gross Margin is by increasing the efficiency within your business.
Your goal here is to put in the same amount of inputs to generate significantly more outputs.
Put another way: Where can you “work smarter, not harder” in your business to produce a BIG growth in revenue?
Example of Optimising Efficiency: Use a more efficient fertiliser.
Fertilisers with similar costs can vary quite a bit in terms of their analysis. You could buy a different fertiliser at a similar price to what you’re paying now, that puts out significantly more N-P-K-S onto the pasture.
That would lead to higher growth of pasture and livestock that graze there.
You’d use the same inputs (cost of fertiliser) for greater outputs (pasture and livestock growth). That’s increasing efficiency!
Strategy #3: Optimise Focus
In this strategy, you’ll use far fewer inputs to create only a small amount of lower outputs.
But wait…doesn’t reducing outputs seem counter-productive to increasing profit? Not necessarily.
Optimising Focus means reducing your costs quite a bit, but having it result in only a tiny bit lower revenue.
Let’s say your original inputs were $20 and the output produced was $40, giving you $20 Gross Margin. If you reduce your inputs to $10, which as a result reduces your output to $35, that leaves you with $25 Gross Margin…which is an increase in the profit you keep!
See how that works? As long as you reduce your inputs by MORE than your outputs, you’ll make more profit.
Example of Optimising Focus: Change your ewe replacement policy.
Let’s say you’re buying in external ewes at $250 each for your composite flock. Instead of selling all your composite ewe lambs at $150— like you usually do — you could keep a percentage of those lambs. Then instead of buying expensive new ewes, you can use those lambs as replacements.
In this way, the input costs (cost of replacement ewes) can be dramatically lowered, by around $100 per animal. And you’ll only end up with a slightly lowered return as a result. That means higher profits!
Strategy #4: Optimise Waste
The final strategy to increase your Gross Margin is to optimise waste by putting in significantly fewer inputs for the same level of output.
Put another way: What should you stop spending time and/or money on, because it’s not growing your revenue?
Example of Optimising Waste: Stop spending money on licks and blocks.
We know from experiments done by CSIRO and other departments of ag that there are situations where licks and blocks are not very effective for the sheep they’re fed to, the same production effect could be achieved by purchasing and feeding more cost effective nutrients.
The cost of the licks and blocks can be quite significant but there’s not much production benefit.
So…you could stop buying them (significantly lowering your input) without really affecting the sheep (the same amount of output). That’s how to optimise waste to create higher profits.
Bringing it all together
Ideally, to increase Gross Margin, we’re looking for a combination of all 4 strategies above.
The goal is to use significantly less inputs to create significantly more outputs → that’s how to generate consistently high profits.
The sum of the parts here is bigger than the individual components. If you can find one way to apply each of these 4 strategies, you’ll see massive increases in your farm’s profits this year.
As always, we’re here to help! If this blog post piqued your interest and you want to learn more about how you can increase Gross Margin on your farm, let’s have a chat. Just send us an email at firstname.lastname@example.org and we’ll get it sorted.
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If you’re loving what you’re reading and want to learn even more about how to apply pro finance lessons to increase profits on your farm, join us for our upcoming free training.
We’ll simplify farm finance and give you plenty more ideas for how you can make more money (ie: reduce your inputs and increase your outputs) without working more hours.