Gross Margin Analysis Helps Producers Enhance Farm Profitability

This article was originally published in The Western Producer.

Successful farmers recognize that gross margin analysis is critical for good crop selection. The gross margin is determined by deducting the direct variable input costs of growing a crop from the gross income of selling the crop. Knowing the gross margin of each crop helps farmers choose the most profitable combination to grow.

The only costs included in this category are those that can be measured and allocated on a crop-by-crop basis. A farm should know with some accuracy the seed and chemical costs of a pea crop compared to a flax crop. However, when asked about the cost of fuel or machinery repairs on a wheat compared to a canola, the farmer would have to use an arbitrary method of allocating the farm’s total cost by acre, number of passes, or as a percentage of gross revenue.

The few studies done involving measurement of these items have shown that differences between crops are generally too small to materially affect crop selection. However, other variables will impact the results. Environmental issues will also influence crop selection, such as disease pressure, chemical rotations and regional factors such as frost free days, average rainfall and heat units. 

Producers who strive for a higher gross margin consistently achieve a better result than those who budget at a lower potential. Simply put, 80% of a large number is still higher than 80% of a small number. This may seem obvious, but over the past 20 years, I have watched producers who use gross margin analysis as a tool to help with their crop selection process regularly outperform those who use intuition or who follow past practice.

Maximizing gross margin is not as simple as typing yields on a spreadsheet, but there is minimal opportunity for long-term success without planning for short-term profitability.

A simple rule to follow is that “less is more.” Generally, the fewer crops selected, the higher the profitability. Gross margin can identify the top four highest profit crops. It follows that farmers who grow more than those are choosing to lower their profits. As well, more crops makes it more difficult to manage production logistics during the growing season. As we all know in the agriculture industry, timing is everything. 

It is easy to fall into a rut of using intuition when picking what we think are the highest gross margin crops. However, it will pay dividends if you force yourself to go through the exercise of calculating it on paper. As the adage goes, “what gets measured gets done.”