Market Advisor

Part 1-Basic Economic Concepts For Running A Profitable Ranch Business

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I’m involved in a Wyoming/Nebraska Ranch Practicum where a cadre of instructors teaches the science of ranching. It’s a multiday, hands-on approach to beef-cow production, range management and basic business economics.

I cover basic economic concepts for running a profitable ranch business. This month, I will share my first lecture and follow up with other points in succeeding columns.

While ranching is generally viewed as a way of life, it’s much more rewarding when it makes a profit. Indeed, profit is generally a necessary condition to sustain ranching as a way of life.

Most ranch owners and employees tend to love the production aspects of ranching, but aren’t very comfortable with the business side. Over the next few issues, I’ll discuss some basic economic and financial management measures of a ranch business, then progress to selected basic production measures that directly impact the economic and financial performance of a ranch business.

As ranch employees are typically asked to collect these production measures, they will benefit from a better understanding of how these numbers are used.

My introductory presentation focuses on four basic questions for a ranch manager:
• What did my family earn this last year from running this ranch?
• What was the net cash flow generated by the ranch business last year?
• Is this the best use of the ranch’s resources?
• How can I make this ranch more profitable?

This month, I’ll address the first two questions. But, before I start, I must emphasize that one can only manage what is measured; if it’s not measured, it can’t be managed. This principle applies to business management as well as production management. So, let’s look at some business management measures.

Question No. 1: What did my family earn by running the ranch business last year?

Figure 1 presents a simplified answer to this question for an example ranch. The top line (operating income) summarizes the total cash income generated for the year under study. This figure is available in your accounting records or your IRS Form 1040F.

The next line (operating expenses) summarizes the annual out-of-pocket costs of operating the business. It also is available from your accounting records or 1040F.

The third line (net cash operating income) is the difference of the first two numbers. In this example ranch, the net cash operating income was $73,535. Some ranchers might be tempted to use this as their bottom-line number, but it doesn’t include depreciation and inventory change for the entire ranch.

While asset depreciation is fairly straightforward and is reported on your annual income tax forms, annual inventory change isn’t generally readily available. Inventory change needs to be calculated and summed for feed, machinery and equipment, buildings and cattle inventories. This inventory change can be positive or negative depending on the business year.

In this example, total inventory change for the four inventories was -$9,640, much of it generated by the changing feed inventory. In this specific ranch example, ranch-raised feed production was down for the year due to poor weather.

Meanwhile, net ranch income for the example herd was $40,025, or $104/cow. This $40,025 is the earned net returns to this ranch family’s unpaid operator and family labor, management and equity capital – the three resources contributed by this ranch family. Thus, this ranch’s answer to the first question – what did my family earn by running the ranch business last year? – is $40,025.

So, what did it cost this rancher to produce $1 of income? Figure 2 presents the analysis.

Total production costs, including operating expenses, depreciation, plus or minus inventory change, are divided by gross income to generate the cost of producing each $1 of gross income. In this example ranch, it cost 83¢ to produce $1 of gross income, which leaves 17¢ of every $1 generated as earned net returns. That’s a 17% profit margin for this ranch.

Let’s go a step further. Let’s assume this rancher wants to bring his son into the business at a $30,000 annual salary. How much additional gross income does the rancher need to generate this added $30,000?

Calculate the answer by dividing the $30,000 added salary by the profit margin (i.e., $30,000 ÷ 0.17 = $176,470). Given today’s $600/cow gross income, this rancher would need to run 294 more cows to generate the $30,000 added salary.

Question No 2: What was the net cash flow generated by the ranch business last year?

A second important business management measure is the annual net cash flow (NCF) of the ranch business. A cash-flow statement, also known as a statement of cash flows, is a financial statement on the flow of cash in and out of the business. As an analytical tool, the statement of cash flows is useful in determining the short-term viability of a company to pay bills in a timely manner.

Figure 3 presents a simplified NCF for my example ranch. Note that Figure 3 starts with the same operating income, operating expenses and net cash operating income numbers as in Figure 1. The additional adjustments, however, are quite different.

In the cash flow account, debt principal paid is subtracted out, as is family living draw and new capital purchases. (Note that not all family living wages were taken from the ranch business because one family member also worked off the ranch.) Capital sales are also added back in. In this example, NCF for this ranch business was $52,360 or $136/cow.

Note that net ranch income and earned net cash flow are two distinctly different business management numbers, and both are critical to the successful business management of a ranch business. The individual components of each measure were identified in each respective table. Take some time and study the differences in Figure 1 and Figure 3.

Harlan Hughes can be reached at 701/238-9607 or harlan.hughes@gte.net.

What's Market Advisor?

Harlan Hughes has spent a professional lifetime helping U.S. beef producers better manage the business end of their beef cow operations.

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Harlan Hughes

Harlan Hughes is a North Dakota State University professor emeritus and author of the monthly "Market Advisor" column that appears in BEEF magazine. He also consults and lectures widely,...

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