Don’t Screw Up the Windfall Profits
2023 is shaping up to be a record profit year for many in the cattle business. I know not everyone is participating as there are regional droughts and specific situations for some, that will take you out of this opportunity. Nevertheless, for some the stars have aligned.
The last time we saw record profits in the cattle business was in 2014 and poor decisions made by ranch managers in 2014 resulted in many hard times for the years to follow. I feel like the crusty old guy sitting at the coffee shop when I say, “Don’t make the same mistakes this time!”.
To understand what these mistakes are, we need to look at the economic and financial structure of most ranching operations. Here are some common problems we find in the way many ranches structure their business:
- Too many employees and people for what the business can support in a healthy way.
- Too much wealth tied up in fixed assets that don’t produce cash flow in excess of their costs.
- Too little money in “liquid” assets.
- Lack of business management knowledge by key people.
Let’s explore each of these problems a bit deeper.
Too many employees: We have a benchmark at Ranching for Profit called GP/FTE. It stands for Gross Product per Full-Time Employee. The most economically healthy businesses are usually exceeding $400,000 Gross Product per Full-Time Employee. If you don’t speak RFP, you might think Gross Product is the same as Gross Revenue. It isn’t. Gross Product is the economic value the enterprise creates. Most ranching businesses have way too many mouths at the table for the value the business is producing. I’m not saying these people are lazy. Usually, it is quite the opposite. However, they often aren’t engaged in tasks or enterprises that are good at adding value to the business. When income is high and money is rolling in, it is tempting to bring Junior home or add people to the business. If your business isn’t exceeding this benchmark or getting close to it, you might be making a problem worse by adding people.
Too much wealth tied up in fixed assets: We all love stuff. Especially machines that make our work easier. As a business grows in maturity it is tempting to invest profits in things we enjoy and things that make our lives easier even if it doesn’t make economic sense. Our rule of thumb is that equipment has an annual ownership cost of 20% of its current value. That means a tractor that is worth $100,000 today, has an annual ownership cost of $20,000 per year. That might strike you as unreasonable, but when you think of repairs, depreciation, insurance, interest, taxes etc. it begins to make sense. If that tractor isn’t producing well in excess of that $20,000 per year, then economically you shouldn’t own it. Most ranches have way too much of their wealth tied up in fixed assets that don’t produce cash flow in excess of their costs. Your neighbors are going to pile their profits into machines that they want but can’t economically justify. This is often done in the name of tax avoidance. Don’t be like your neighbors. Pay the dang tax if you have to, or deploy the money somewhere in the business that will improve profitability and make the tax problem worse next year.
Too little money in “liquid” assets: Liquid assets are cash, or those things you can quickly turn into cash. If you had to get your hands on cash in 2 weeks, how much could you comfortably come up with? What are the annual costs of keeping the doors open on your farm or ranch? What % of your annual operating costs are available to you in short notice? Our recommendation is that at least 50% of your annual operating costs should be available to you with short notice. For many farms and ranches this number is closer to 5 or 10%, well below the target. This often leaves the business with their back against the wall when things go bad. The next drought, flood, fire or market crash is just around the corner. Prepare yourself by having adequate reserves.
Lack of business management knowledge by key people: Ranchers are often very skilled at raising livestock, but many stink at running a business that raises livestock. Does your ranch have clear roles and responsibilities, economic projections for the coming year, cash flow budget and plan, clear mission and vision for the business, grazing and operating plan, regular strategic work sessions, regular operations work session, a clear succession plan that is communicated.
If your business has some holes in the list above, you’re not alone. But the profits from this year could be an opportunity to invest in your key people, to help them build the skills to produce the results your business needs. Ag business owners are rightly taught to be frugal. Unfortunately, this frugalness spills over into being cheap when it comes to investing in our people. Our recommendation is at least 1 month’s salary per year in professional development. If that isn’t occurring on a consistent basis that is a problem.
I hope 2023 is a record year for you. I hope you deploy the profits from 2023 to build a stronger and more resilient business for the years ahead. I would be honored if Ranching for Profit can be part of helping you build that business. Registrations for our 2023-24 schools are at an all-time high. Many of our winter schools are close to full. If you want to attend a school this winter I strongly recommend that you get registered now with a deposit to secure your spot for the school you want to attend. We look forward to seeing you in the classroom!