Tuesday, August 5, 2014

Check Margins before Scaling Up

Farms start off at a small scale for many reasons but many owners realize they want or need to expand. Expansion  most often presents the potential to increase from a part time income to earning a full time income from the farm. Before you decide to expand you'll want to check your "operating margin". Here is a basic technique to evaluate your operating margin (there are often many ways to do these calculations but let's keep it simple). Use this cash flow statement here.

·         Add up all your income for the previous year
·         Subtract variable expenses and fixed expenses. These are the costs for materials, supplies and services used in the previous year. Don't include capital activity (purchase of long term equipment, buildings or land with cash or loan payments)
·         How much money is left? (on the cash flow link below this is the line that says "receipts minus expenses at the bottom of page 1).

If you show a positive number at this point you can consider expansion and evaluate your ability to invest in business assets (capital activity) or draw out more income as the owner (this is page 2 on the cash flow).

If you calculate a negative number STOP! Expansion could make the financial situation worse. An extra 5 ewes held over from last years lambs or an extra .5 acre of vegetables might not help. Think about strategies to get your costs more in line with the income you generate. Expansion might resolve the problem but it is not a guarantee.

Download this simple cash flow PDF and complete it to the bottom of page 1. The line "receipts minus expenses" will indicate your operating margin and assist in decision making moving forward.
 (by Mark Cannella, University of Vermont Extension)

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