TDA 1
Penster 4
Introduction to Farm Business Management AEC431
At the end of this lecture students
should be able to:
Define gross margin
Complete gross margin analysis
Appreciate the importance of gross margins
Identify its uses in farm busineses
Identify the limitations of gross margins
Definition
gross margins are determined by subtracting operating
variable costs (those costs which change in proportion
to changes in production) from the income for the
enterprise.
gross margin = enterprise operating income –
enterprise variable expenses
Also defined as “income above variable costs”
Enterprise operating income
the total value of the enterprise growing season and
therefore includes
the value of all production
the value of enterprise inventories,
Where inventories affecting the enterprise are retained
from one period to the next, a trading account must
also be used to show the effect of changing inventory
values during the period.
Enterprise variable expenses
The conventional approach to the determination of
enterprise variable expenses is to include only variable
costs that satisfy the following two rules.
(i) enterprise specific; and
(ii) vary in direct proportion to the size of the
enterprise.
A simple test of variability
"if the level of production increases by 10 percent will
this cost be expected to also increase by the same
percentage?". If the answer to this question is yes then
the cost is variable if it is not then the cost is not a
variable cost, and may be either a fixed or capital cost.
Operating variable costs can be extracted from the
Farm Working Account
In practice…….
it may be more difficult to separate some costs into
their appropriate enterprise, because they may be
shared between more than one enterprise.
If costs are difficult to allocate to a particular
enterprise, these costs can be considered as an
overhead and not allocated as variable cost
This should not be done if they form a significant
portion of the total cost, and some other reasonable
method of allocation can be determined
Livestock gross margin
$ $
Cattle 92309
Produce income 0
Enterprise transfers from cropping 0
Total enterprise income 92309
Operating expenses
Enterprise expenses 32614
Enterprise transfers to cropping 7000 (40tx$175/t)
Total enterprise expenses 39614
Enterprise gross margin 52695
Crop Gross margin
Income
Ginger 75,000
Enterprisetransfers from livestock 7,000
supplementary feeding-40tx175)
Total enterprise income 82750
Operating expenses
Enterprise expenses 19277
Enterprise transfers to livestock 0
Total enterprise expenses 19277
Enterprise gross margin 63473
Perenial Crop Gross margin
Income Yr 1 Yr 2 Yr 3 total
Pawpaw
Total enterprise 82750 86000 87000
income
Operating
expenses
Enterprise 19277 19200 19000
expenses
Enterprise
transfers to
livestock
Total enterprise
expenses
Enterprise gross 66800 66800 68000 198273/3=66091
margin
Note…..
Transfers of produce between enterprises must also be
taken into account when determining enterprise
operating expenditure to reflect ciate with the
enterprise. In the case study, additional Costs of
supplimentary feeding are added to the livestock
enterprise because of the transfer of feed from the
cropping enterprise
Importance of gross margin
analysis
Note that:
total enterprise gross margins are of of little value in evaluating enterprise
performance.
total gross margins cannot be compared
to each other
or industry averages.
necessary for the gross margin to be related to the factors limiting production
in the business. (e.g land, livestock, water for irrigation or enterprise capital).
RETURN TO LIMITING RESOURCES
For example, a cropping and a livestock enterprise could be compared on the
basis of their respective gross margins per hectare, per limited capital, per
limited labour.
I
Use of Gross margin analysis
To assist the farm business person with the following decisions:
Relative profitability of various business enterprises- analysis assists managers
to identify the important factors influencing profitability.
Industry comparisons may be made to enable the industry best practices.
Identification of the strengths and weaknesses of an enterprise to enable the
development of strategies to improve performance.
Enables the most profitable enterprise combination to be planned within the
technical limits of each enterprise,
assist to maximise effective use of limited farm business resources.
It shows the contribution that each enterprise makes to fixed costs, interest, and
capital expenditure. Therefore enterprises can be compared on the basis of their
gross margins provided fixed costs are the same
For example in the last bullet point
If there were three enterprises, sheep, ducks, crops
and their gross margin per ha each was
1) $1200/ha for sheep
2) $3,000/ha for ducks
3) $8,000/ha for crops
The above figures shows each enterprises contribution
to fixed cost if fixed cost is common.
Limitations of the gross margin
1 Only takes variable expenses into account
2 Ignores husbandary potentials of enterprises
3 Assumes linearity
4 Generally uses land as the limiting factor
5 Assumes independency
6 The gross margin does not measure profit..
Conclusion
Gross margin analysis is a quick way of making
decision in farm businesses. However it must be used
with caution as major decisions must not only use
gross margin analysis but other types of budget to
confirm that it is the best decision based on available
information.