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Gross margins 2 - Answers

Using these notations to represent the key elements involved, complete the 'formula' to represent the definition of a Gross Margin
GM = I - VC
Answer the following
1. What is the definition of a Variable cost?
  Costs that are the direct result of an enterprise and change with the level of production or size of the enterprise eg. an increase in stock numbers causes a corresponding increase in associated costs.
2. How do Fixed costs differ from Variable costs?
  Overhead costs have to be met regardless of the size of the enterprise or level of production eg. bank interest on a loan is always payable no matter what or how much you produce in an enterprise.
3. Identify the following costs as either Fixed or Variable for an animal enterprise:
  Variable costs = drench, vaccine, casual labour, ear tags, wool bales, supplementary feed, selling costs
  Fixed costs = rates, depreciation, permenant labour, bank interest
How does a GM differ to a calculation of Profit?
Profit would also include Fixed Costs ie P = I - (VC+FC)
The GM is a figure in dollars related to a particular factor eg $/ha. If you are to use the GM to compare enterprises they must be expressed in similar units.
1. Name 5 typical resources used as units upon which GMs are quoted.
  land, labour, capital, irrigation water, dry sheep equivalent (dse)
2. What additional information would you need to know to enable you to determine the best enterprise choice in the following case:
  - Cattle enterprise GM = $268/breeding cow
  - Fat lamb enterprise GM = $21/breeding ewe
  to compare $/cow and $/ewe you would have to know the carrying capacity of the farm ie. how many ewes can graze on the same area as one cow? Using a standard GM/dse would give a better comparison.
Outline the two main uses of a Gross Margin.
1. provides a starting point for decisions on changing enterprises on a farm by allowing a comparison of relative profitability.
2. allows analysis of actual performance of an enterprise against the published standards for the district.
Why are GMs less useful in comparing enterprises that are very different in their needs for land labour and capital eg intensive cropping vs animals?
As variable costs only are included, enterprises which are significantly different in their needs for land type or amount, permanent labour input, equipment or expertise can't really be compared using GM alone.
Discuss 6 factors, other than GM comparison, that a farmer should consider before undertaking a major enterprise change.
1. is the soil, climate, land area etc suitable for the proposed alternative enterprise?
2. would it be better to attempt to improve the present enterprise instead of change?
3. could a period of learning and adjustment be needed before the new enterprise can produce efficiently?
4. perhaps the proposed new enterprise entails a greater risk level eg. climatic or market sensitivity.
5. is cash flow similar ie. when and how are returns received?
6. does the alternative appeal to the farmer, will they enjoy doing the associated work?

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Calculate the change in the GM/cow (including pasture costs) if supplementary feed (hay and grain) to the value of $1650 was needed due to a period of drought.
Income remains at $38,801

minus original VC of $11,969 plus new VC $1650 = $13,619

new GM = $25,182 for 100 cows

new GM/cow = $251.82 ($16.50 less than before)
The establishment and production of a fodder crop eg. sorghum, costs the farmer $1850. What effect does this have on the GM/cow (pasture costs included)?
Income remains at $38,801

minus original VC of $11,969 plus new VC $1850 = $13,819

new GM = $24, 982 for 100 cows

new GM/cow = $249.82 ($18.50 less than before)
The use of this fodder crop increases the dressed weight of the steers for sale to 225 kg. Assuming the farmer receives the same price/kg as before (237c), is the production and use of this sorghum crop worthwhile?
a 225kg dressed weight steer at $2.27/kg earns $510.75/head, 42 steers return $21,451

Total Income is increased to $39,847

minus original VC of $11,969 plus new VC $1850 = $13,819

new GM = $26,028 for 100 cows

new GM/cow = $260.28 which is still $8.04/cow less than the original GM so this is not a recommended strategy
Describe two ways in which the farmer may be able to achieve the desirable 5% increase in weaning percentage of calves that will greatly improve the GM.
1. Better disease control may increase the number of calves reaching weaning
2. Selective breeding programs to use bulls and cows which have better weaning % performance; feeding strategies to improve lactation in cows and hence calf survival and growth.
Other than improving the weaning % or providing additional fodder, describe strategies the farmer could adopt to improve the GM.
1. look at decreasing costs eg; investigate any savings in using AI program rather than keeping and replacing bulls, using more efficient disease management or using more disease resistant breeds to decrease livestock and vet costs, use of alternative marketing systems could reduce selling costs eg CALM or direct marketing and niche marketing.
2. investigate ways of increasing income by use of different breeds or improved bloodlines to increase growth rates, yield or quality of the product. Develop alternative markets or undertake value adding.

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Which area of Variable costs is most expensive for the farmer? Explain why would this be the case?
Harvesting is the most expensive general area of VC. Lettuce would probably be harvested by hand and hence very labour intensive and costly.
How could the introduction of some innovative technology improve this situation?
It is suggested that the use of 'harvesting aids' would decrease the harvest time by 50%. These aids could be specialised machines that automatically harvest the crop or are used to more efficiently collect the harvested heads from the field or are involved in grading and packing.
Suppose a genetically modified lettuce has just become available and the newly created variety is resistant to most normal lettuce diseases. This lettuce will require the use of only one chemical spray, Benlate ( 3 applications as before). What is the revised GM using this variety of lettuce?
Income remains at $14,000.00

minus reduced VC ($11,293.33- $719.40 nil sprays) = $10,573.93

= $ 3,426.07

this is greater than the previous GM/ha of $2706.67
The genetically engineered lettuce seedlings are more expensive, costing $75.00/1000. Is it still a better option for the farmer? What other implications are there?
Original seedlings were $50/1000 x 31,000 = $1550

GM seedlings are $75/100 x 31,000 plants = $2325, a $775 extra cost

Income remains at $14,000.00

New VC($10,573.93 + $775 extra for GM seedlings) $11,348.93

= $ 2,651.07

this is less than the previous GM/ha of $2706.67

The farmer may consider that a $55.60/ha reduction in GM is little to pay for a considerable reduction in pesticide use and its potential detrimental environmental consequences. There is always a tension between short term gain and long term sustainability. The question of the future impact of genetically modified plants and animals in the environment and the human food chain is also an issue to be addressed.
The graph following the GM indicates that price received by the farmer fluctuates considerably throughout the year. Describe and explain the trends seen in the graph depicting monthly lettuce production and prices received.
As the amount of lettuce available for sale increases the price received decreases. This is a simple function of supply and demand interacting to determine the equilibrium price. There is a certain demand for lettuce by consumers, if there are not enough lettuce to meet this demand people will pay more for the product to ensure they get some eg. April 95 $10/carton and available supply of about 28,000 cartons. Alternately when there is a glut of lettuce it must be offered at a lower price to attract customers to the product eg. Dec 93 $4/carton when supply exceeds 45,000 cartons. Fluctuations in supply tend to be seasonal where more lettuce can be grown in summer months than winter. Demand for lettuce is also seasonal as its main use is as a salad/summer food.
The table following the GM shows the effect on GM/ha as price for lettuce changes. Evaluate the sensitivity of lettuce to a price fall and suggest strategies the farmer could use to minimise risk.
Lettuce GM is very sensitive to price changes. Even a $1 a carton price drop drastically effects the return/ha. Diversification is one way to spread risk ie grow some less sensitive crops as well. Growing varieties that are better suited to normally low yielding seasons to capitalise on expected higher prices can decrease sensitivity.
More stable prices could be achieved by entering into a growing contract with an end user eg providing lettuce at an agreed price, under contract to a restaurant chain.
The prices of vegetables fluctuate greatly throughout the year and from year to year. Suggest some reasons why vegetable prices show such fluctuations.
Vegetable prices fluctuate according to the supply and demand for each vegetable. When the weather causes a decrease in the supply of a particular vegetable the price rises as the demand exceeds supply. If the weather causes an increase in supply of a particular vegetable, the price drops as the supply exceeds demand. Other factors that may effect the price fluctuations include: increase in demand due to particular climatic conditions eg. lettuces are demanded more in hot weather for salads and increase in demand due to a particular traditional meal eaten at a certain time of the year.
You will have noticed that there is a considerable difference between the GM/ha for lettuce and the GM/ha for Yearling beef. Why wouldn't the beef producer simply convert to lettuce farming as it seems there would be around $2500/ha more to be made?
Look back to question 6. Beef and Vegetable growing have significantly different requirements for overhead costs so a GM alone is not a good means of comparison. Land and soil quality needs would be very different as would equipment and necessity for proximity to markets. The type and location of country suited to a yearling beef enterprise is unlikely to support an intensive vegetable enterprise. Other factors outlined in question 7 should also be considered eg risk, cash flow, technical expertise needed and farmer preference etc.

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