Manage your business costs
We all know to be a successful farmer your business must make a profit and we know the basic formula is PROFIT = INCOME - EXPENSES (or costs). Over time farming businesses have gone through cycles of emphasis.
Several years ago, the emphasis was very much on maximum profit which led to increasing production on a farm regardless of anything else. Production methods received attention with the aim of increasing income regardless the negative affect on the natural resources.
Farmers experienced that they could not keep this up. Profits were dwindling because natural resources were damaged, and costs continued to increase. More and more production inputs such as fertiliser had to be used to increase production. Today the emphasis is on farming sustainably. You must still make a profit, but the profit must be made without depleting our natural resources – soil, water, grazing and wildlife.
The emphasis must thus be on managing your income as well as expenses. In past articles we have discussed increasing income from different perspectives. Thus, in this article we will attend to the expenses of a farming business.
As expressed in our introduction PROFIT = INCOME - EXPENSES (or Costs), income reflects all or total income of the business and the costs are all or total costs.
Total costs are divided into production or variable costs, overhead or non-variable costs, fixed costs, foreign factor costs and personal cost. Production costs is a function of production – the more you produce the higher the production costs will be. Or, if you produce nothing, as in nothing, during a year, production costs will be zero. Production costs are also described as directly allocated variable costs as they can easily be allocated to an enterprise – maize, cattle, sheep, and so forth. These costs could be seed, fertiliser, herbicides, pesticides, marketing costs, feed, licks, veterinary costs, remedies, casual labour, and others.
To manage these costs properly it is necessary to measure these costs and allocate them to an enterprise.
Overhead costs are all costs that cannot be allocated or are very difficult to allocate to a specific enterprise. Such costs could be fuel, electricity, lubricants and repairs. These costs are also a function of production but are difficult to allocate if not measured very accurately and when there are many enterprises using the same resource.
Fixed costs are costs such as depreciation, insurance on buildings and implements, licences, regular of fixed labour, bookkeeping fees, bank charges and training costs. These costs are not related to production – even if you do not use your tractor at all for a year you are obliged to pay the license. Whether you do it, that is something else, a risk you take. Even if it does not rain and you have no crop, these costs must be paid.
Foreign factor costs
Then there are foreign factor costs such as interest on loans and rent on land leased. These costs are not directly related to production.
Lastly, personal costs or your salary will include every cent spent on yourself and your family. Remember this cost is directly related to farm profit. If your business does not make a profit you cannot pay yourself a salary.
According to the formula PROFIT = INCOME - EXPENSES (or Costs), it is quite obvious that to reduce costs is the only way it will affect profits positively. Thus, costs must be managed.
Practical measures to manage costs
- Draw up a budget and spend according to the budget. A budget is mentioned as the first measure because it is the most important manner to control expenditures. Should you have compiled a budget you are already managing your costs. Remember to manage implies to plan, to organise, to implement and to control – a budget is your plan. Discipline yourself when purchasing and when incurring expenses and spend according to your budget. If you wish your business to survive you have no option. Spend in a disciplined way.
- Control all stock of production inputs such as seed, fertiliser, and other stock such as fuel, spare parts, small tools such as spades, hand tools such as spanners, and so forth. Put measures in place to prevent or at least reduce the theft of stock.
- Ensure that production inputs are used correctly according to the prescribed instructions – do not over use or under use inputs.
- When purchasing anything to be used in your business always shop around if possible and negotiate for a better price, make use of a system of requesting quotations or request a tender or form a buying group with your neighbours. Buying in larger quantities can be cost saving.
- Consider and plan telephone calls, trips with the bakkie or tractor.
These are but a few measures to take to control and to keep purchases in check. To control purchases, you need information which requires records. As the saying goes ‘The bluntest pencil is sharper than the sharpest memory.’
Publication: December 2019