What Is Your Breakeven?
Know Your Breakeven and Use It (Don't File It) to Make Critical Management Decisions
By Joe Huddleston
Regional Vice President, Lending Services
Stephenville, Texas
If you run any kind of business, it is vital that you know your operation’s breakeven. Establishing this important piece of information requires knowledge of all the inputs involved within the business as well as the potential production output of the operation. As for agriculture, an industry challenged by such factors as weather conditions, changing markets and consumer demands, it is critical that producers know their operation’s potential and what it costs to produce a unit in the most economical way.
Whatever the issue or factor being examined, you need to know your breakeven in order to make sound financial and production decisions to generate a positive bottom line.
Each Business Has Its Own Breakeven
While it is helpful to know how your operation compares in meeting industry standards, a producer needs to go one step further to determine his or her individual breakeven, with all outlays being considered. These outlays not only include operating expenses, but living expenses and debt obligations too. An operation may be profitable but unable to generate adequate profits to meet the rising costs of family living expenses and/or debt-servicing requirements. No two agricultural operations are exactly alike; many have similarities, but each one has its own breakeven.
The starting point for most breakeven analysis is to know and understand your operation’s direct and indirect operating costs. It may be somewhat easier to calculate the breakeven for a beef-cattle or row-crop operation than, for example, a dairy operation because there are fewer cost-variables involved. Also, changes in income caused by fluctuating yields, production levels or calf-crop percentages can significantly change breakeven projections just as much as variations in expenses can.
A more complex operation can appear even more difficult to analyze because the numerous variables are always changing, some even on a daily basis. This is where enterprise accounting can be helpful. Enterprise accounting can allow a producer to identify strong or weak points within their operation.
Conservative Approach Is Best
Breakevens are no better than the information they are based on. I highly recommend taking a conservative approach, supported by historical averages. If reliable information has gone into the calculation process, you can even analyze expansion possibilities using projected breakevens. The key is to use a dependable, consistent source of accurate information. Unfortunately, too many farm businesses have record-keeping systems that are inadequate for tracking historical information, but this doesn’t have to be. There are some excellent computer programs available that can be used to track income and expenses and to quickly calculate various financial scenarios.
Due to the uncertainties involved in an agricultural operation, it’s important to review the many different variables when doing an analysis, and to think through the various “what ifs” or “shocks” regarding income and expenses. A projected breakeven can reveal opportunities or problems that may occur, usually on a short-term basis. Remember, breakeven analysis is not just an exercise; it is a strategy that should be carried out faithfully and not filed away with business plans.
Cash-flow projections compiled from the input data summarize the total income and expenses of an operation. With that information, you can complete a breakeven analysis based on the summary totals using different variables. The next step is to monitor cash flow and make the adjustments necessary to meet financial objectives. Risk management tools and marketing strategies can also limit or prevent significant variations in the outcome of breakeven analysis.
Accrual Accounting Best Reflects Profitability
To get a true picture of profitability, the producer needs to go one step further and make accrual adjustments to the income statement. Changes in receivables, payables, inventories, accrued expenses, accrued interest, taxes payable and the issue of deferred tax liabilities all need to be taken into consideration. Businesses may adopt cash management strategies that give the appearance — but not the substance — of profitability, by selling down inventories, living off depreciation, selling non-essential assets, accumulating accounts payable, accruing expenses and even refinancing operating losses. Many business owners do not have a good grasp of accrual accounting and thus need to hire professional accounting assistance, which adds another expense. Although cash accounting is used in many cases for tax purposes, it is recommended that an accrual accounting system be implemented because it will more accurately reflect profitability.
Too many businesses have failed or developed serious problems in the last two decades simply because the producer and/or their lender did not recognize that something was wrong. Good financial management and knowing your breakeven is not a cure, but it can serve as a preventive tool. Regular checkups and control measures prevent many small problems from becoming serious ones. Breakeven analysis also can help identify strengths and weaknesses within an agricultural operation, including low yields, low prices, high operating costs, excessive living expenses and an overabundance of debt-servicing requirements.
The bottom line is to know your breakeven. |
