24 March 2000

Gross margins hard to work out

CONTRACTING businesses are experiencing competitive and challenging times. As with other traditional farming enterprises, gross margin and fixed cost analysis should be applied to identify the stronger and weaker parts of the business and help determine future strategy.

Calculating gross margins for a contracting enterprise is less straightforward than for other farm enterprises, however, the introduction of computers and spread sheets will assist.

A gross margin can be calculated for each service provided. The income is based on the contracting charge per acre/ hectare or hour and the anticipated annual workload for that operation.

The variable costs include the ownership cost of the machine expressed as a depreciation charge over its working life or the annual hire purchase capital and interest payments. Other variable costs are annual charges for fuel, repairs, labour, bank interest, road fund licences and insurance.

Historic records of total work undertaken by a machine and average work rates, detailed recording of individual machine repairs, labour costs and a breakdown of annual insurance premiums should provide most of this information. More approximate guide figures can be used if actual figures are unavailable.

The annual variable costs for each tractor and implement can then be calculated. These two costs can then be combined to give a cost per operation either per hour or per acre when adjusted for average work rates. The method is similar for self-propelled machinery such as harvesters.

The annual labour cost should be proportionally divided between all the vehicles based on the annual hours worked for each and included as a variable cost.

Subtracting this operation cost from the operation income will give a total gross margin per operation and a per acre/hectare figure.

This gross margin figure will not be exact, however, it will give an initial insight into which operations are likely to be performing strongly. Calculating the cost of individual tractors and matching specific tractors to specific operations will give a more accurate measure as to the performance of each operation.

This calculation should be repeated for each operation to form a total gross margin for the enterprise. From this the remaining fixed costs of the business need to be subtracted to derive the actual net margin.

Complications can occur where the contracting enterprise is part of a larger farming business. In this instance machinery maybe used for farm work and specific contracting work. To avoid this problem it is more straightforward to assume that all the machinery is owned by the contracting business and hired to the other farm enterprises at the prevailing commercial rates.

Once this analysis has been undertaken the whole enterprise can be reviewed to identify where improvements to the various operations can be achieved to enhance the current gross margins.

Agricultural contracting has become very competitive in recent years. At the same time some items of machinery have become more specialised and costly to own. It is therefore crucial that the contracting rates charged for providing a particular service generate a positive gross margin and allow the additional fixed costs to also be covered.

Without knowing how each operation is performing, identifying a long-term strategy for as particular contracting business will be very difficult to achieve.