So how do you make the demand for your product more inelastic? In the extreme case, products have very inelastic demand (you can charge a high price) if they have no (or few) substitutes. So the key to increasing your price is to find products that have attributes for which there are few perceived substitutes. This includes things like the services you provide — ration balancing, forage testing, periodic feeding program reviews and product use recommendations — that differentiate you from your competition. In the grain business, increased selling prices come from procuring and utilizing good market information, networking and being plugged into buyers as well as providing excellent service. (See Figure 3)
Reducing costs of goods sold means analyzing where your costs are and how efficiently you produce feed products or handle and market grain. Typically, a company’s largest income statement costs are labor costs. This is where it pays to look at your labor, and perhaps some industry metrics such as tons of feed produced/employee/period (month or quarter or year), or bushels of grain marketed/employee/period. In these cases, a larger number is preferable, and you can compare it to published studies that may be available from your trade association. If you don’t want to use the volume figure (tons or bushels), sales dollars work equally well – and this goes for the measures discussed below as well.
Additional metrics can be calculated using other cost items divided by output volume.Two examples are (use bushels of grain instead of tons of feed for the grain business): salaries/tons of feed produced (would be a measure of administrative overhead/ton of feed) wages/tons of feed (measuring hourly labor cost/ton of feed). In these examples a lower number would indicate a more efficient operation.
Pretty much all of the operating expense line items that appear on your income statement can be converted to a ratio that you can track through time and/or compare with others in your industry. The idea here is to develop some historical data you can use and to also measure your performance against others, so you can take appropriate corrective actions if needed.
Item 2 under Finances on our report card refers to your business having sufficient equity. How do you increase the equity in your business and why is it important? Equity flows into your firm from primarily two sources — retained earnings (dollars left from firm profits after any payments to investors as dividends have been paid) and infusions of cash from investors. Increased profitability should lead to increased retained earnings and thus increased equity. An often examined ratio is the firm’s debt/equity ratio with a healthy number ranging from 50% to 150% (discussed more later).
The second method mentioned relates to increasing the firm’s equity by additional investment by shareholders or owners. It may not be the most preferred method because one of the basic tenets of increasing the return on owner’s investment is to use someone else’s money to make money for owner/investors.
The above concept of leverage relates very well to items 3 to 5 under the Finances area — determining whether or not your feed and grain company has a plan for generating additional equity, the relationship you have with your bank (or commercial lender) and the amount of debt you are carrying. Basically, your plan for generating additional equity can be the strategic plan you have for your business, including a profit (and thus retained earnings) goal. It should be noted, however, that there may be a need for additional equity infusion by shareholders if profits do not materialize as planned, or if additional investment is needed in assets to achieve growth goals (infrastructure, inventory, accounts receivable, etc.).
Your bank relationship is a two-way street and should revolve around periodic and consistent communication with your lender. Your lender should understand your business so an occasional e-mail or letter with news or clippings (good or bad) relative to happenings in the feed and grain business can keep that person up to speed. It can be a good idea to provide periodic accounting statements to this important partner in your business. Yes, we know that many times you may not want to share operating results (good or bad) outside of your company but there is much to be said for an open and trusting relationship with your banker.
Finally, the point relating to the amount of debt your firm is carrying goes back to the leverage concept mentioned previously. A commercially acceptable debt/equity range is from 50% to 150%. Any ratio higher than 100% reflects more debt than equity and should be viewed with caution. Increased leverage increases risk and has a potential impact on the cost of additional funds you may need to borrow.