Earns And Turns
My friend, Mike Boehlje, a professor at Purdue University, made a profound statement while addressing a producer conference recently. In his energetic voice, he stated that producers who are business-oriented should go to bed at night thinking about “earns and turns.”
Let’s examine this statement. “Earns” is all about profit margin. In an economic world that is flat, profit margins have and will continue to be squeezed. To increase profit margin on the reverse side, one must examine the marketing plan and strategy to execute. What enterprise is making you money? Is it the focus of your business strategy?
On the cost side, what are the biggest cost centers of your business? Usually they are cropping expense; feed, if you are livestock oriented; interest cost, if you borrow money; and labor. What is your strategy to reduce these major expenses at a rate less than inflation? Sometimes variance analysis, comparing actual to projected performance, is a useful tracking measure.
“Turns” is all about asset utilization. This concept is measured by the capital turnover ratio (assets divided by revenue or value of farm production). For example, if revenue is $500,000 and assets are $1,000,000, the capital turnover ratio is 0.50. This means it takes the business two years to turnover its capital. If the ratio improved to 1.0, then one million dollars of assets would generate one million dollars in revenue, which indicates more efficient utilization of assets.
Management Tip of the Week:
Multiplying the profit margin by the capital turnover ratio will generate rate of return on assets. For example, a profit margin of 16% (revenue minus cost) multiplied by a capital turnover ratio of 0.50 (the first scenario above) equals return on assets of 8%. In the second scenario, if margin remains 16% and capital turnover ratio is 1.0, the return on assets is 16%, and sweet dreams as one drifts off to sleep.
Editor’s note: Dave Kohl, The Corn And Soybean Digest Trends Editor, is an ag economist specializing in business management and ag finance. He recently retired from Virginia Tech, but continues to conduct applied research and travel extensively in the U.S. and Canada, teaching ag and banking seminars and speaking to producer and agribusiness groups. He can be reached at [email protected].