What separates the average from the good or great when it comes to bottom line profitability? This question was the subject of discussion for a focus group of owners and managers who were about to embark on a two-day strategic planning session. Let's draw upon decades of engagement with an aspiring, proactive mindset.
The first observation one can glean is that there is a drive toward operational efficiency and overall margin. Managers of highly profitable businesses will drill down on the overall cost of production and for specific enterprises. In an inflating environment, they know the cost of production is a moving target and break-even points can quickly change overnight. They will incorporate global, regional, and local weather in decision-making. Some managers in this group utilize technology to conduct predictive analytics. They know that information and data can be used as a tool to bring objectivity to the subjective aspects of farming and ranching.
Speaking of financials, profitable producers know the power of earns, referring to margin, and turns, or capital asset turnover. Whether it is a farm or ranch operating over multiple regions or smaller more traditional operations, generating positive margin combined with the efficient use of assets is a recipe for success. The additional nickel and dime gained from doing the extra tasks for production and operational efficiency are compounded by the asset base of land, labor and capital being fully utilized. The “bird poop” principle can be applied during a quick walk around of the business. Assets that are accumulating bird poop are often not fully utilized and eliminating some of these underutilized assets can improve capital efficiency.
Earns and Turns in Action
Multiplying the margin by the capital turnover rate equals the return on assets (ROA). For example, if the margin is 10% and the capital turnover rate is 0.50, meaning every two dollars of assets generated one dollar of revenue, then the ROA is 5%. If the margin improves to 15% and the capital turnover rate increases to 0.60, then the ROA increases to 9%. The most profitable business managers know that one needs to exceed both the cost of borrowed money, the inflation rate, and opportunity cost of alternative investments to register financial success in the long run and to build wealth. This is particularly true in the current inflationary environment which impacts both capital investment and bottom-line margin.
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