[Market-farming] big difference between gross profit and gross profit MARGIN

jasperm1 jasperm at iquest.net
Wed Feb 9 21:03:37 EST 2005


Pat Meadows wrote:

>
>So I cannot see, no matter how much an accounting rule it
>may be, that it would always be beneficial to have a certain
>percentage of gross profit margin required per crop.  
>
There is no accounting rule dictating any acceptable gross margin.  A 
business model may be built on any margin assumption but that like any 
other "plan", is subject to the intrusion of reality.  There are some 
pretty profitable businesses built on less than 50% margins (most as a 
matter of fact) but again are we talking true gross margin or say a 
materials margin or what?  If you have a high velocity of turnover you 
can get the same results on less margin.  That is why break even analysis 
is in my view more important sometimes.  If you sell $1000 a week at 50% 
variable costs margin with fixed costs of $200 or you sell $2000 a week 
at 25% variable costs margin at $200 in fixed costs what is your gross 
profit.  $300 in each case but your "margin "is 1/2.  If you can sell 
$3,000 a week on the 25% then your variable margin is still the same but 
if your fixed costs remain the same you bring home another $250.  I am 
not advocating joining a race to the bottom on pricing but there is 
something to be said for finding the "sweet spot" for pricing.  I liken 
it to coming up on a plane in a sailboat.  You kind of waddle through the 
water as you gain momentum and rise partially out of the water then all 
of a sudden you feel a burst of speed and the hull sings to you.

And I will throw into the pot of ideas that it isn't just about "margin" 
you have to consider what is called transaction costs and carrying costs. 
 If you have built an organization where everything gets double and 
triple checked for errors etc. you may very well have a pretty high 
transaction cost.  So if you have 70% margin but you can't get an invoice 
through your system for less than $15 then you are losing money on every 
sale of $21 or less.  If you have a boat load of something that takes 6 
months to sell you have to shed it, maybe carry a loan on it etc.  These 
things should be in the calculation of "true" Gross profit/margin but 
need to be considered individually in decision making rather than waiting 
to see how they "average out".

>Maybe this is a flaw of considering everything from the
>standpoint of 'financial books'.

As in my other post I would agree that not every meaningful metric is 
contained in the financial records.  In some ways they are the "average" 
of a lot of little things.  When you look at them at the end of the year 
they are more like the weatherman telling us we had an "average of X 
inches per month" of rain for the year.  Never mind that May you couldn't 
get into the field because it was a monsoon and in August the tomatoes 
keeled over because there was a drought.  The average was ok.  You may 
make out on the beans in one year and lose it in the tomatoes or 
whatever.  Margin analysis is best done on the logical subsets of your 
activities.  Did you make money going to that extra farmers market or did 
you end up working harder and getting nothing for it once you factored in 
your costs and lost time etc.

The financial books tell you on average how you did.  The more frequently 
you look at them (ie. monthly say versus annually) the more likely they 
can help you make better decisions in time but in the interim if you can 
at least have a handle on margin and what you need to cover your fixed 
costs (break even) you can make better choices.  if you need $500/ week 
to make ends meet then the guy or gal selling $1000 at 50% margin after 
the other $200 in costs isn't going to make it but the one selling $3000 
at 25% is.

Another thing is as much as you try to be accurate, financial books are 
based on a lot of estimates.  You may say the estimated useful life of 
your EZ up is 3 years but if someone takes a little bit better care of it 
or gets one made a little better it may last say 5 years.  So once you 
really know that the thing is really going to last 5 years you can look 
back and say the depreciation I took in those first 3 years was a little 
too much and I was actually making more money than I thought and these 
last two years I was paying tax on more money than I was actually making. 
 The point and there really is one is that the more accurately you 
project your costs and the demand for your products the closer you can 
shave your models margin.  The more squishy your numbers the more you 
better be able to count on a big margin to succeed.  The higher your 
fixed cost the less flexibility and again that puts pressure on having 
either a great margin or huge demand that can be counted on.  Look at the 
Airline industry.  I read somewhere that at this point the airlines have 
lost the equivalent of every dollar ever invested in them.  I think most 
of it was lost in the last 10-15 years of how many years of passenger 
aviation.

I suppose by now eyes are rolling and people say how would you know this 
stuff.  Try keeping a 3X5 card.  Head one up Tomatoes or XYZ farmers 
market and just try to keep a log of guesstimates of what you spent 
getting there.  It may not "balance" but it will potentially be eye 
opening.

Cash flow anyone?

Anyway I ramble again,

Mike

"In a time of universal deceit, telling the truth is a revolutionary act."
                                              --George Orwell

"Beer is proof that God loves us and wants us to be happy."
                                              --Benjamin Franklin

Central Indiana Zone 5b




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