Uncategorized

Trading in the $4,425,925 Pick-Up Truck

I met with a discouraged farmer recently.  Let’s call him Farmer Jones.  In summary, Farmer Jones was concerned that “there ain’t no money in farming!”  We talked about options for increasing margins and decreasing risk (both good topics for another day), and then I left him leaning on his pick-up truck, pondering the impact of increasing feed prices on his bottom line.

As I got home, a thought struck me.  One simple change would have re-written the financial fate of the Jones Farm, and we were leaning on it the whole time:  The freshly-financed 2014 Ford F250 Lariat Diesel 4×4 pick-up truck.

A quick search found an identical truck at a local dealer for $73,526 (See burgundy truck below.)  Farmer Jones had financed the truck, but let’s give him the benefit of buying it outright, for the sake of a simple calculation.  The same dealer listed a nearly identical 2009 version of the truck (without the fancy Lariat leather seats), showing 50,000 miles on the odometer  (See white truck below.)  The price was $24,324, for a difference of roughly $49,000 between the 2014 and the 2009 with fewer options.

Let’s imagine now that Farmer Jones had been in the habit of buying the 5-year-old truck for his entire career, starting at age 25.  He had replaced it after 5 years each time, with another 5-year-old truck.  Again, using rustic math, we divide the $49,000 difference in price by the 5 years of use, and find that he saved about $10,000 per year.

If Farmer Jones had invested the difference into the US Stock Market, he would have made 12% interest every year on average, during any 40 year period (his career) since the great depression in the 1930’s.  That figure comes from Dave Ramsey, America’s financial planning guru.  We’re farmers, so let’s use a slightly more modest 10%

A sum of $10,000 per year, invested at 10% for 40 years, results in $4,425,925.  Yes, that’s 4 million, thanks to the power of accumulated interest.  And if that money were re-invested into a well-managed farm, the return would be similar.

Its safe to say that Farmer Jones isn’t aware of to the real cost of his fancy transportation, and not sure why he retired with a shiny truck but very little money.  In Texas, they call that “all hat and no cattle.”

Christian

ImageImage

Advertisements
Standard
Uncategorized

What Would Dave Ramsey Do?

Rachel and I have the privilege of hosting Dave Ramsey’s Financial Peace University at church, starting next week.  If you are familiar with Dave Ramsey, you know he’s been on a mission to get America financially fit for two decades, a quest he began after filing for personal bankruptcy and learning a great deal in the process.

Dave has a simple plan for personal finances, and has recently adapted it to small business. His plan is based on Biblical principles, most notably:

Just as the rich rule the poor, so the borrower is servant to the lender.  Proverbs 22:7

This verse gets some serious reactions, it turns out.  Everything from:

That’s just old-fashioned and ridiculous. You can’t run your business without debt, much less your life.  How do you ever grow, or get the stuff you want?

to:

I can’t believe the impact this wisdom has had on my life and my business.  I wish I would have adopted the mindset earlier!

After having a few dozen conversations on the matter of debt, please allow me to share a few observations:

1.  The Bible does not say it is wrong to be in debt.  It only explains the risk (becoming a servant to the lender.)  

2.  A person can obviously make more money faster when using debt, for example by borrowing at 4% to invest in an opportunity that pays 6%.  (A person can also lose money faster if the assumptions aren’t correct, or conditions change.)

3.  One’s mindset changes when holding cash.  Personally, I have been tempted to buy things with borrowed money (for fun or business) that I wouldn’t have forked over the cold, hard cash for if it had been in my possession.

4.  Nobody ever opens up and says “man, I sure wish I would have leveraged more.”  

5.  There are some folks out there who have made a great deal of money without using debt, including Dave Ramsey himself.  Apple, Bed Bath and Beyond, to name a few, also operate without debt.  

6. And there are a lot of finance professors with incredible understanding of financial leverage who are broke.

What does this mean for a small business or farm?  Everything.  You can’t go bankrupt if you don’t owe money.  You can’t be forced to sell anything, and you don’t have to send your financial statements to the bank so they can tell you if you’ve violated a loan covenant.  

Just like Dave, I’ve had the privilege of trying both strategies.  And just like Dave, I promise that life is more peaceful with a deep respect for Proverbs 22:7.  

 

Standard
Uncategorized

How to Price a Product (Part 2/2)

The second aspect of pricing a product, then, is “what do you need to make?”  There’s room for some artistic license here, but “two times variable costs” is a good rule of thumb.  To explain, let’s start with two definitions:

Fixed Costs:  The money it takes to run your farm or business, without ever making a product.  This includes property taxes, building maintenance, and most electricity bills.  Conveniently, in a small farm, many of the fixed costs are part of running your household anyway. 

Variable Costs:  These increase when you make a product.  For example, chicken feed for broilers is a variable cost.  It increases only when you’re feeding a chicken for sale.  Packaging for eggs is also a variable cost.  Labor directly related to production is a variable cost, like the hourly rate for feeding the chickens. 

Lets go back to the egg example, a dozen eggs selling for $6.  As mentioned before, the variable cost (also known as cost of goods sold in this case), should be half of the selling price.  Thus, if you can make a dozen eggs with $3 in variable cost, and sell it for $6, you make a $3 gross profit per dozen, and should be decently happy with yourself. 

The gross profit, of course, exists to first absorb your fixed costs (if you sell 1,000 dozen eggs, your gross profit can absorb $3 x 1,000 or $3,000 of fixed costs).  Once your fixed costs are absorbed, the rest is PROFIT!

To summarize, (1) the market determines price in direct competition.  You determine price when you have a unique product that customers want.  (2) You should be happy to sell your product for two times the variable costs you spent to produce it.  And (bonus), once your gross margin (the money left over after variable costs are covered) exceeds your fixed costs, you make a profit!

That’s a mouthful, I know.  Write me a note or a comment with any questions!

Christian

 

 

Standard
Uncategorized

How to Price a Product (Part 1/2)

“If I sell eggs and lose $1 per dozen, how many dozen do I have to sell to break even?”  It’s a silly question, of course, but I’ve seen countless well-meaning farmers try to answer it by trial-and-error, on their way to getting a job in town.

I’d rather ask, “if I sell eggs and make $3 per dozen, how many do I have to sell to quit my job in town and make my dream job my real job?”

What’s the difference between the two farmers asking the questions? One of them knows how to price a product for sale. 

There are two aspects to pricing any product:

1.  What will the customer pay?

2.  What do you need to make?

Let’s start with the first one, “what will the customer pay?”  It’s really the most important, because it doesn’t matter what you need to make on a product if no customers will buy it at that price.  To begin, consider existing pricing in the market for products similar to yours.  If three farmers in your town are selling a dozen eggs for $6, that’s probably what people will pay.  Its not likely, if your eggs cost $9, that people will buy them.  That is, UNLESS (and this is a BIG idea when it comes to small business strategy) your product is BETTER.  If all the farmers in your town are selling eggs (pasture raised) for $6, you can charge more money if you offer something better, like pasture raised PLUS organic certification.

A strategic aside:  The best businesses in the world grow not by offering incremental improvements on existing products in the market, but by offering something completely different.  A famous egg farmer in Italy sells his eggs for $18/dozen.  How?  His chickens roost in trees.  He feeds them organic grains raised on the property and soaked in milk from a goat herd that exists only for the chickens.  He spends several hours each day hunting for eggs in trees, on buildings, and in shrubs.  And he’s happy to have help from every journalist and high-end restaurateur who wants to join him.  His product is better.  It’s more fun, and has NO EQUAL.  In that case, he gets to be more creative with the price.  (The opposite, of course, is what economists call “perfect competition.”  The best example is corn sold to the co-op; all suppliers bring an equal product, and the market dictates the price.  This environment is bad news, and best suited for going out of business unless you are the most efficient producer in the market.)

Standard