The up and down nature of our commodity prices nowadays can make it hard to know what to sell, what to buy and when. Unfortunately, we have no control over what the general market prices do. When looking at how your business performs across a few years, the best protection you have against fluctuating price received is your cost of production (COP).
Cost of production is calculated by taking your total costs and dividing it by your total kilograms (or tonnes) produced. As long as your COP is less than market price, you'll have a profit margin.
It is worth pausing to remember you don't make money by receiving the highest price for what you sell. You don't make money by being the tightest scrooge around and not spending any money. The businesses who have the highest profit are the ones with the biggest gap between what they get paid and what it cost them to produce it (COP). This gap, or margin is the area to focus on.
So, given we have very little control over price received, let's talk about COP. How do you decrease your cost of production? There are only two ways to do it.
- Decrease your costs. There are some costs that you can't do anything about (e.g. rates, levies, some R&M). There are some costs that you can influence to a certain degree (e.g. insurance, phone bills, commission, labour). However, there are a lot of costs that we have more choice around the what, where, when, who, why, how (e.g. supplement, professional fees, selling platform - saleyards vs on farm sale/A+, animal health, fertilisers/chemicals). The important step is to not go into auto pilot on those costs that you can influence or have a choice is what you're doing. Treat each dollar you spend as an investment and ask what return each investment is going to give you. Is there a better option that will cost less or give you more production for the same cost?
- Increase your productivity. If you can produce more kgs or tonnes from the same cost base, then that will reduce your COP as those same costs are spread across more units of production.
What about capital expenditure. Money you're investing in new assets/development etc. If decreasing COP is something you'd like to do in your business, then it can be made quite simple. Is this investment going to decrease your costs and/or increase your production levels? If not, then it is possibly only going to increase your COP!
- David is chairman of agricultural consulting and education company, RCS Australia. www.rcsaustralia.com.au 1800 356 004
