Profit – What is it Anyway?
At the Ranching for Profit School since we talk about profit, we believe we better define it. We ask the participants at the school to come up with a definition of profit, they usually respond with something like Income – Expenses = Profit. Let’s play with that definition some and see how it works.
If we are in a drought year and sell off 30% of the cow herd what happens to the cash income? It goes up, right? What happens to that winter’s expenses with feeding those cows? Goes down, right? So did we make a big profit? No, we sold off a wing of the factory. What if we have a year when we decide to grow the herd by keeping all our heifer calves and breeding them the following year? Income goes down and expenses go up. Did we make a huge loss? No, we added a wing to the factory. The point is, profit is more than just cash income minus cash expenses. We need to track the value we are creating. Your banker tracks this through your balance sheet, more specifically by looking at changes in earned net worth. At the school we teach a more practical approach to project profit using the RFP Economic Model.
But wait … there’s more! Just because your neighbor reports having made a profit, can you really compare their numbers to yours? After all your neighbor is 3rd generation on the place, doesn’t make land payments, doesn’t owe any money on cows or machinery and we know one person works in town to cover most of the family’s living expenses including health insurance. How can we compare profitability of that operation to one that is a startup? When we do economic analysis we remove all the crutches ranchers often use to prop up their business. Here is the way we define profit:
Can you pay:
- Cash rent for the land
- The full cost of labor (no one works for free or steeply discounted)
- Interest on all assets used in production (cows and machines)
- All other production costs (feed, vet, etc.)
Using this definition of profit how many of your neighbors are profitable?
This might seem like a high bar, but it is a really useful high bar. It allows us to compare 3rd generation operations with startup operations on the same metrics. It allows for profit targets to be established and for the uses of profit to be defined.
When we say profit we need to be speaking the same language. Profit is not what you pay yourself for the work you contribute to the business. It is a value the business generates above and beyond the contributions of the labor force. Are you Ranching for Profit?