Question

XYZ Bakery's general manager was puzzled by the results of the income statement for the month which showed a net loss for the bakery. The owner is puzzled because of the volume of customers who flood the bakery each day for baked goods. The owner calculated the cost of direct materials and direct labor and was sure the prices were set right and overhead was estimated based on prior year expenses. How is it possible that volumes could be high but the store could lose money? What are other factors the owner should consider to make sure next year's financial statements report net income?

Answer 1

The factors the owner should consider to make sure next year's financial statements report net income are as follow:-

Number of Production Units
The most basic factor affecting profit in any business is the number of production units. This may be acres for the farmer, cows for the rancher, or factories for the industrialist. It doesn’t matter what business you are in, your potential for profit (or loss) is closely tied to your number of production units. If you have an enterprise that is generating $50 of profit per acre and you could double the number of acres, then you would have twice as much profit. Losses, unfortunately, work the same way; more of a loser just loses more.

Production per Unit
The productivity of your land and livestock also has an impact on profit. Productivity is measured in yield per acre, weaned calf crop percentage, and weaning weight for starters. This is an area where farmers and ranchers tend to concentrate. When profitability wanes, it is natural to try to increase productivity. It is important to remember that production per unit is only one factor affecting profitability. It is also hard to increase production without also increasing costs.

Direct Costs
Direct costs are those costs that vary with production. Thus it’s other name: variable costs. These are costs that wouldn’t occur if you did not produce. Seed, fertilizer, feed, and veterinary expenses are all examples of direct costs. Direct costs can be attributed to one or more enterprises. Farmers and ranchers often try to deal with profitability problems by reducing direct costs. Care must be taken however, or a drop in productivity will also result.

Value per Unit
Value per unit (price received) dominates farmer and rancher discussions. Unfortunately we have little control over the prices we receive. We generally accept what the market dictates. Often steps can be taken to move into higher segments of a market, such as certified seed or more timely marketing. This is limited however, and the benefits gained are often at an increased cost.

These first four factors deal with the profitability of individual enterprises. The final two deal with the operation as a whole.

Enterprise Mix
The enterprise mix deals with how enterprises combine to influence overall profits. Different enterprises have different levels of profitability. There are many reasons why farmers and ranchers choose to have several enterprises. Crop rotation demands diversification. Diversification spreads the risk. It can also spread out the workload and decrease peak labor demands. Wise enterprise selection contributes to both long and short-term profitability. Concentrating only on profit in the short run encourages growing what is “hot.” This often increases risk and can jeopardize long-term profits.

Overhead Costs
Overhead costs are those costs that do not vary with production. All costs are either direct or overhead. Overhead includes operator living withdrawal and “killer toys.” Common examples of excessive overhead in traditional agriculture include: expensive tractors, expensive bulls, fancy shops, too much equipment, and excessive family draw. Finding yourself in the predicament of excessive overhead often isn’t due to an extravagant lifestyle. Many producers find themselves with excessive overhead costs when two generations try to make a living from the farm or ranch.