There’s more to showing a profit than balancing your books every month. Of course there are several financial measures that determine your operation’s efficiency and profitability.

“Profitability measures the financial performance of an operation over a period of time, usually one year, because it includes decisions regarding use of land, labor, capital and management resources,” says Mike Swan, agricultural education professor at WashingtonStateUniversity.

Comparing your pork business to other top operations is a good place to start. Financial benchmarking can help you answer the question, “How should my operation be performing if it’s going to be competitive in the pork industry?”

“At the very least, your operation needs to perform better than average,” notes Swan. “More likely than not, average performance won’t be good enough long term.”

He says farm business associations, such as the Center for Farm Financial Management in St. Paul, Minn., are sources that you can tap for benchmarking data. These groups usually obtain benchmarks by averaging the actual performance data from a large group of operations. The high-profit benchmarks usually come from operations that rank in the top one-fourth to one-third of the group.

Swan suggests doing your homework to get a clear understanding of how an association gets its benchmark data. This includes the time in which the data is collected; methods used to summarize income, expenses, assets and liabilities; as well as details on how the benchmarks are calculated.

Size doesn’t matter when it comes to refining your operation’s profitability. After all, profit is the name of the business game, especially if you plan to expand. For instance, if you plan to add another 2,000-head finishing building, the figures used for comparison to benchmarks can help you determine if it’s a wise financial move.

In measuring profitability, the first thing to look at is net operation income, says Swan. (See sidebar for an example of calculating profitability for a pork operation.) This gauge is frequently used as the “bottom line” of an income statement. Net income doesn’t include gains or losses from selling capital assets. It includes things such as unpaid family labor, management and any other money that is leftover from lower input costs.

For greater accuracy in calculating your net income, Swan suggests that you make accrual adjustments to your cash receipts and expenses. You want to itemize where expenses and receipts are actually going. This can cover anything from selling your hogs to buying feed. Accrual adjustments take into account changes that affect your revenue, such as accrued interest and accounts payable. One such example is if you hire a temporary employee for a day and pay him cash.

Swan points out three other financial measures to review to get a handle on your operation’s finances:

 

  • Rate of return on assets — This measures the net income generated by all of the operation’s assets, after labor is paid, but before interest payments. He notes that interest is a financing expense, not an operating expense.

    “The rate of return on assets is probably the single best overall measure of operating performance,” says Swan.

  • Rate of return on equity — This measures the business owner’s return for his capital investment. The return comes after all employee and interest expenses are taken into account. 

    When you calculate ROE it can leverage equity capital so that it benefits you—provided that you use debt productively, says Swan. (See sidebar for  an example.)

    “ROE needs to exceed ROA for operations that borrow money,” says Swan. “If it doesn’t, it means that borrowed capital isn’t earning enough to pay the cost.”

  • Operating profit margin — This measures the proportion of earnings or revenues that are considered operating profit. This figure also reflects your ability to make money and control costs.

    “A pork operation with a high operating profit margin is generally a low-cost producer,” says Swan. “If the operating profit margin is low, you may need to cut costs. You also may need to look at producing higher value products.” (See sidebar for an example.)

The bottom line is that you need to look at the big picture of your pork operation’s finances. Looking at one financial measure only gives you a snapshot of your operation’s profitability, but using all of them will give you a panoramic picture of your finances.


Setting an Example

Mike Swan, agricultural engineering and education professor at WashingtonStateUniversity, developed this example to show the profitability of the fictional ABC Pork operation. You can do the same for your operation by plugging your numbers into the various equations.

The benchmarks used here are a four-year average from the Adult Farm Business Farm Management Program for similar operation types in five of the major pork-producing states. They are only guideposts. Operations and real-world influences vary. 

Net farm income for ABCPork:

                         Gross revenue ($1,967,156)

             –          Interest expense ($89,617)

             –          Other Expense ($1,714,614)

             =          Net Farm Income ($162,925)

Return to farm assets:

                         Net Farm Income ($162,925)

             +          Interest ($89,617)

             –          Family Living ($120,000)

             =          Net return ($132,542)

             ÷          Total Assets ($3,556,674)

             =          Return on Assets of 3.73%

Return on farm equity:

                         Net Farm Income ($162,925)

             –          Family Living ($120,000)

             =          Equity Return ($42,925)

             ÷          Equity ($3,435,730)

             =          Return on Equity of 1.25%

Operating profit margin:

                         Net Farm Income ($162,925)

             +          Interest ($89,617)

             –          Family Living ($120,000)

             =          Net Income ($132,542)

             ÷          Gross Revenue ($1,967,156)

             =          Operating Profit Margin of 6.74%

Profitability benchmarks:

In the profit margin, ABC Pork’s 6.74 percent is well below the 20 percent vulnerable benchmark; it is in the center of average assets for ROA and below average for ROE. ABC Pork needs to improve its profitability in order to stay in business long term.

These benchmarks are from averages of the top operations in the top five pork-producing states in the country. This table shows that for the operations compared, their profit margins hit between 20 percent to 35 percent, the ROA is between 1 percent to 5 percent and ROE is between 5 percent to 10 percent.