Benchmarks are Overrated
At the Ranching for Profit School, we teach people how to use benchmarks to identify deadwood in their businesses which allows them to find focus areas for managerial leverage. When we finish teaching the benchmark section participants are excited to run their numbers in the RFP format and compare them to the RMC Benchmarks to see how they stack up. While I’m a fan of the benchmarks as a tool, I worry people often think the benchmarks are the silver bullet. Just like all tools in your bag, benchmarks have a place and a use, but they are not the first thing you reach for in every job.
The first thing we need to look at is the economic profit created by the business and check in with how it matches up with the goals of ownership. Economic profit is the value created after covering all costs. We need to look at economic profit by division and enterprise within the business.
The following is an example economic summary of a ranch that has a cow-herd, develops heifers and makes hay:
The economic profit at the bottom is the beginning of the story. Once a ranch gets this far in their calculations it is time to look at the financial picture. Remember economics is different from finances. Economics asks “is this profitable” while finances asks “can we afford it and how does the cash flow”. We might come up with a great economic plan, but it might require huge sums of capital or the cash flow might stink. Who cares if we’re profitable in 24 months if we can’t afford to keep the heat on this winter in the meantime. Alternatively, a ranch that has no debt might be happy operating with little to no economic profit. Most of our clients are carrying some debt and have expansion or other goals that they need profit to accomplish. So we need to establish the debt service target and other uses for profit to see how we are doing. A few key financial indicators will help tell the story.
Now it’s time to turn our attention back to the economics and this is where the benchmarks can be helpful to develop strategies to hit our targets. The benchmarks are guideposts to draw your attention to areas that may need to be addressed. However, sometimes we are unwilling or unable to address those areas that the benchmarks highlight as a problem. In the example used above, overheads are high. The benchmark is less than 40% but our ranch is 80%. When we look into overheads for this place, we find labor is high and land costs are high. Maybe this is family labor and generational land, perhaps both of which the ranch is unwilling to address. Let’s see if we can fix it through turnover and gross margin instead. If we fix the gross margin on the cows and find a way to scale the heifers on the existing overheads the outcome looks much better.
Benchmarks are useful, but they may not be the best place to start. We need the complete economic picture including key financial indicators, and profit targets to give management focus. This will allow them to get to work structuring the business to produce the results ownership wants.
The Ranching for Profit School is the place to come to learn how to do an economic analysis of your operation and develop the skills to understand what it means and identify potential changes in your operation to improve the profitability of your business. Isn’t it time you started Ranching for Profit?