Balancing the Enterprise Mix

It is beyond the scope of this blog to get too in-depth in discussing the economic and financial analysis tools that are needed to perform a full analysis of your Land Business and its various (actual or contemplated) enterprises. Attending one of the classes listed at the end of my last blog is an excellent means to learn how to use them and their importance to the long-term success of your business. However, I will introduce one of my favorite analysis tools, Gross Margin, and give a simple example to illustrate how it can be utilized in the decision-making process.

Gross Margin – this is a means of measuring the production efficiency of an enterprise and how much it can contribute toward covering Overhead Costs.  The formula is quite simple and is as follows:

Gross Product minus Direct Costs = Gross Margin

A few definitions to aid in our discussions:

Gross Product – The revenue received for your product. This should be enterprise specific.

Direct Costs – Expenses that vary with the production unit amounts or sizes. These expenses are tied to specific enterprises within the business. Often referred to as Variable Costs. Examples – feed costs, vet/med costs, special or temporary labor (specific to an enterprise), etc.

Overhead costs – Expenses that are relatively constant regardless of what or how much is being produced. Often referred to as Fixed Costs, although they can vary over time and circumstances. These costs are typically tied to the Land Business. Examples – land taxes, accountant fees, your salary, most land-based repair and maintenance, etc.

I like Gross Margin as it tends to give a good initial “feel” for whether an enterprise may be worth pursuing. This is a handy tool and can be expressed in various $/units (per acre, per animal unit, per dollar invested, etc.). One of my favorites when comparing various enterprises that do not have an obvious common unit of measure is the “per dollar invested”. This will allow you to compare, let’s say, your Cattle Enterprise to your Agritourism Enterprise (no obvious comparable units of measure other than dollars). It gives you a comparison that is “apples to apples”. 

An example: (not necessary based on a real situation)

Cattle Enterprise                                                                  Agritourism Enterprise

Gross Product $100,000                                                     Gross Product $7,500

Direct Costs $ 60,000                                                          Direct Costs $2,500

_____________________                                                             ___________________

Gross Margin $ 40,000                                                        Gross Margin $5,000

GM/$ invested $  0.67                                                         GM/$ invested  $  2.00

Landowner, Katie, feeding her cattle at KCK Farms.                  Recreator, Melissa, accessing land at MT Cow Company.

Looking at this example, it would appear that you should put all your effort into the Agritourism Enterprise due to the good marginal reaction per dollar spent – and maybe you should - to a point.  However, you can’t ignore the $40,000 that the Cattle Enterprise is contributing to help cover Overhead Costs, it is a very important enterprise. This is why it is so important to remember that this analysis is only one of many measures that you should be utilizing when making decisions on the enterprise mix for your business. Other factors such as cash flow, total operational/business profit, etc. must be considered and weighed against your financial needs and your three overarching goals. Advice from your accountant and financial advisor or banker should be sought to avoid unintended consequences and provide another point of view (all part of the “team effort” for success). 

The example was only comparing two enterprises. I have heard of some landowners that account for 20+ enterprises on their land. This brings us to the consideration of – Are you a “lumper” or a “splitter”? I like to see operators that are sort of in between. In the example above, the Cattle Enterprise could have a cow/calf component and a yearling component. Both, most likely, have differing Gross Margins. It would be useful to know which has the best Marginal Reaction so management adjustments may be made to improve the component that is lowest. Also, the Agritourism Enterprise may have several activities or components that each bear scrutiny for best Marginal Reaction. The upshot is – if you “split” too much, you can lose focus looking at details and miss the big picture. If you “lump” too much you will lose valuable insight to what the data could tell you. 

At the end of the day, the Landscape, Production/Financial, and Quality-of-Life Goals you developed will provide the main standard to measure decisions against. All decisions should pass the test of helping you attain all three of the goal areas. Granted, not all of the three parts may be equally addressed – however, as long as the decision isn’t a major detractor from any one part and contributes significantly to the other parts – it may be a good decision and appropriate for your business. I suggest you keep a poster, with your goals spelled out, in an obvious place so you and your team can refer to them during decision making sessions.

We are striving for BALANCE (and profit) in your operation!!!!