Track your costs

Tracking business costs seems like an obvious task, but too many growers guesstimate and don’t keep an accurate record of costs. If you know your costs, you can set appropriate prices and be more profitable.

Some growers may cite lack of time and lack of experience as reasons why they don’t track costs. But it’s a step that’s vital to your company’s success.

Michigan State University developed a spreadsheet for nursery growers to estimate cost of production (COP) on a per-unit and total enterprise basis. Find it at the MSU Extension bookstore at http://bit.ly/1aHGRsr. Cost is $26.

The spreadsheet generates estimates for total economic cost, meeting net worth cost, meeting cash flow demand cost and necessary sale price to attain a projected profit above the estimated total economic cost. Primary inputs are from business income tax returns and costs from records or suppliers. Cost estimations from the spreadsheet are compared to costs from the previous year from Schedule F and nursery records.

Tom Fernandez, associate professor of horticulture at Michigan State, helped create the worksheets with Tom Dudek, extension educator at MSU Extension and Roger Betz, farm management agent at MSU Extension.

“I came from a small family nursery, so I understand the needs and difficulties of running a nursery operation,” Fernandez said.

The team created the worksheets to help growers understand costs and how they’re distributed within the overall business enterprise. Once these costs are plugged in, growers can improve cost management and production efficiency, Fernandez said.

“With a better handle on costs, growers can set the appropriate sales price needed to recover costs,” he said. “The worksheets also help growers evaluate how new production techniques or new plants affect production costs.”

Drill down
Costs are separated into variable (direct) costs and overhead (indirect) costs. Direct costs change proportionally as the units of production change. Indirect costs tend not to change as units of production change. Direct cost per unit of production are entered directly into the enterprise budgets. Five worksheets help calculate some of these estimated direct costs, including fertilizer, pesticides, substrate, overwintering materials and various direct labor costs.

Indirect costs are allocated to the unit of production using the concept of square foot weeks. Square foot weeks is determined by multiplying the average area (in feet) by time (in weeks) that it takes to produce the crop.

The Enterprises worksheet is used to describe the enterprises that will be tracked throughout the rest of the spreadsheet. Enterprises can be set up however the user wishes to track crops. For example one user may choose to track crops for a particular species while another may track by final product size. This spreadsheet can track 25, 50 or 100 separate enterprises, so for nurseries with product mixes less than 25, each product can be tracked. For nurseries with larger product mixes, crops will need to be grouped into similar cost categories unless the user is proficient with Excel.

The Income worksheet captures information from the previous year through sales, materials and labor cost records, inventory and tax returns. These figures are used to calculate total income, direct costs, indirect costs, total expenses and net business income. Total income, direct costs and total expenses are used only as a comparison to estimated costs in the other worksheets. Indirect costs are used to estimate an indirect cost for the year being evaluated.

The Cost of Production worksheet combines all previously entered costs and requires inputs of other direct costs that are typically provided or easily calculated as a per unit cost (containers, liners, tags, etc.). A weighting factor is included in this worksheet to allocate overhead to operations that require more infrastructure or other indirect costs. For example more indirect costs may be expected in container production than field production due to the development of production beds, irrigation and drainage, and other infrastructure that is typically not necessary for field production. This value is entered at the user’s discretion. After these costs are entered, a section of this worksheet provides a comparison of projected costs for the current year with recorded costs from the previous year from the information entered in the Income worksheet. A difference between previous year costs and current estimated costs should be expected due to actual changes in costs between years but this section of the worksheet provides a “reality check” of estimated costs to recorded costs. Other factors that could result in differences include changes in number of units produced, changes affecting pest pressure thus pest management cost and changes in labor efficiency, for example.

Three types of cost estimates are calculated further down the COP worksheet.

1. Total economic cost (which includes direct and indirect costs, opportunity costs and interest costs)
2. Maintain net worth cost
3. Meet cash flow demand cost

The value of unpaid labor and unpaid equity capital are entered and it calculates the total economic cost per unit sold based on the estimate percentage of the crop sold. Recovery of this cost covers all direct and indirect costs plus opportunity costs based on unpaid labor and equity capital costs.

“If you sell your plant for over the total economic cost, you made a profit,” Fernandez said.

The maintain net worth costs is determined by entering income taxes paid and other family expenses and subtracting unpaid labor and equity costs. If a business does not have family expenses or unpaid labor expenses these cells should be left empty. Recovery of this cost will allow a business to maintain its net worth from one year to the next.

“Tracking this cost helps you determine if or how many capital improvements you can make or if you can service your debt, for example,” he added.

The meet cash flow demands cost is the final cost calculated. The cost of principal paid to reduce debt, interest and capital (infrastructure) replacement is included. Recovery of this cost will allow service of business debt and planned replacement and growth of the nursery without additional borrowed money.

The COP Summary worksheet shows how projected sales and estimated costs affect cost recovery per plant by enterprise, per enterprise and combined nursery on a total economic cost, maintain net worth cost, and meet cash flow demand cost basis. Once actual sales quantities and sale prices per enterprise are known for the year there is a section further down the worksheet to enter these values. The worksheet uses these values to analyze how actual sales and estimated costs resulted in cost recovery for the three types of cost estimates; per plant by enterprise, per enterprise and combined nursery.

The Sale Price Projection worksheet estimates a break-even sale price based on meeting 100 percent, 90 percent and 70 percent of the projected sales entered in the Enterprises worksheet for the three types of cost estimates. This demonstrates the effect of missing goals on the price increase needed per plant to recover estimated costs. Basing sales price solely on estimated costs does not provide a buffer in case sales goals are not achieved nor does it provide for a profit. The next section of this worksheet allows the user to enter a profit goal and calculates an estimated sale price to meet this goal based on meeting 100 percent, 90 percent and 70 percent of the projected sales entered in the Enterprises worksheet.

Getting started
The biggest barrier is simply getting started, Fernandez said.

“It may seem overwhelming, but users can start with just a few crops at first, then expand as they get comfortable with the system,” he said.

And looking at a per-plant cost helps growers set better prices to recover costs and make better production decisions.

“When you see in the worksheet that you’re not recovering costs on a crop, it becomes obvious you need to do something to be more efficient or choose a new crop,” he said. “It eliminates the guessing. It shows you what can happen if you bump up your price per plant by a penny or whatever amount you choose.

“It helps growers see what they’re buying, if they’re buying more than they need, and if they need to buy something different, such as a new type of fertilizer.”

And just as important, the spreadsheet shows how discounting plants affects profitability, he said.

“Discounts should be added to your costs in the worksheets,” he said. “Then you’ll see how much it actually reduces your profits.”

Growers can set profit goals into the worksheet. It also allows growers to evaluate the costs of a new practice that’s being investigated.

“If you’re thinking of buying a mechanical potting machine, you can put in hypothetical costs and compare those to hand labor. It’s an excellent way to help with investment decisions,” he said.