The operating profit margin ratio tells us how the percentage of revenue that remains once the farmer has paid for the cost of production.
The operating profit margin ratio is one of the key profitability ratios used in farm financial analysis.
Operating Profit Margin Ratio Formula
Operating Profit Margin Ratio = Operating Profit ÷ Total Revenue
This article is a part of our series on Farm Financial Performance Ratios.
Description
Operating profit margin measures the percentage of revenue retained as operating profit after deducting operating expenses from total revenue. It provides insights into how efficiently a farm’s core business activities generate profit.
Operating profit margin is a fundamental metric for farmers to gauge the profitability and efficiency of their farm operations. By understanding and monitoring this metric, farmers can make informed decisions to improve financial performance and sustainability.
Remember that operating profit is not the same as net income! Other expenses such as taxes and interest on loans must also be taken out. However, this ratio tells us whether the core operation is profitable or not.
Calculating the Operating Profit Ratio
The operating profit margin is calculating by dividing the operating profit by the total revenue of the farm operation.
Operating Profit Margin Ratio = Operating Profit ÷ Total Revenue
To determine the equity to asset ratio, you will need to find the Total Assets and Total Equity on a balance sheet. See the example to the right.
Operating Profit is the profit earned from the farm’s core business operations, calculated by subtracting operating expenses from total revenue. Operating expenses typically include costs directly associated with production, such as seeds, fertilizers, labor, machinery, and maintenance. An easy way to find the operating profit is to subtract the cost of goods sold from total revenue.
Operating Profit = Total Revenue – Cost of Goods Sold
Total Revenue is the total income generated by the farm from selling agricultural products, including crops, livestock, and any other sources of revenue. Note that in some cases, Total Revenue is also known as Gross Income. These two terms are used interchangeably.
Review our example to locate these two numbers on the income statement.
A full breakdown of both operating profit and total revenue can be found in our article on The Basics of Agricultural Income Statements.
Guided Example
To understand the Operating Profit Margin Ratio, please review the example below.
Say for example that a farmer has total crop and livestock sales of $500,000 in a given year. Also assume that this same farmer has operating expenses of $400,000 which was required to produce the crops and raise the livestock to maturity for sale.
With both of these numbers, we can figure out the operating profit margin.
To calculate a equity to asset ratio, start by taking our formula:
Operating Profit Margin Ratio = Operating Profit ÷ Total Revenue
Revenue in this case is already known. However, we also need to find the operating profit.
Operating Profit = Total Revenue – Cost of Goods Sold
Operating Profit = $500,000 – $400,000
Operating Profit = $100,000
With the operating profit now known, one can find the operating profit margin ratio by plugging the numbers into the equation.
Operating Profit Margin Ratio = Operating Profit ÷ Total Revenue
Using our formula, we arrive at 20% as the operating profit margin ratio.
Operating Profit Margin Ratio = $100,000 ÷ $500,000
Operating Profit Margin = 0.2 = 20%
What this tells us is that the farmer is profitable and have a margin of 20%. In other words, the farmer’s operation is taking in 20% of total revenues as operating profit, which is generally pretty good. Remember that this is not the same as net income! Other expenses such as taxes and interest on any loans must also be taken out before earning true net income.
Ideal Operating Profit Margin Ratio for Farmers & Ranchers
The ideal operating profit margin ratio can vary depending on factors such as the type of farming operation, industry norms, and economic conditions. However, generally speaking, a higher operating profit margin ratio is preferred as it indicates greater efficiency and profitability in the farm’s operations.
Based upon industry averages, farmers should look to attain an operating profit margin ratio of at least 15% or higher. Maintaining an operating profit margins above 25% indicate a very healthy and well run operation!
It’s important to note that the ideal ratio may differ across different agricultural sectors. For example, some highly specialized or value-added agricultural operations may have higher operating profit margins, while commodity-based farming operations may have lower margins due to tighter profit margins and market volatility.
Ultimately, the ideal operating profit margin ratio for a farm depends on its specific circumstances, goals, and industry benchmarks. Farm managers should aim to achieve a ratio that allows for sustainable profitability, covers operating expenses, and provides a return on investment that aligns with their financial objectives. Regular monitoring and analysis of the operating profit margin ratio can help farmers assess performance, identify areas for improvement, and make informed decisions to optimize profitability.
How to Improve Your Operating Profit Margin Ratio
Improving this ratio involves strategies aimed at increasing revenue and/or reducing operating expenses to generate more profit from core agricultural activities. Here are several approaches to enhance the operating profit margin ratio:
Increase Revenue
- Diversify Product Offerings. Explore opportunities to diversify product offerings or add value to existing products to attract higher-paying markets.
- Expand Market Reach. Invest in marketing efforts to reach new customers or expand into new geographic markets.
- Focus on High-Margin Products. Identify and prioritize products with higher profit margins to maximize revenue potential.
Optimize Operational Efficiency
- Streamline Operations. Identify and eliminate inefficiencies in production processes to reduce costs and improve productivity.
- Invest in Technology. Implement technology solutions such as automation or precision agriculture to improve efficiency and reduce labor costs.
- Negotiate Supplier Contracts. Negotiate favorable terms with suppliers to reduce input costs and improve profit margins.
Control Operating Expenses
- Reduce Overhead Costs. Review and renegotiate contracts for utilities, insurance, and other fixed costs to lower
operating expenses. - Labor Management. Optimize labor scheduling and training to improve productivity and reduce labor costs.
- Inventory Management. Implement inventory control measures to minimize waste and reduce carrying costs.
How the Operating Profit Margin Ratio Used
The operating profit margin is a critical financial metric used by farmers and agricultural businesses to measure profitability of the operation.
In its most basic sense. it helps assess the efficiency and profitability of farm operations by measuring the percentage of revenue retained as operating profit after deducting operating expenses. A higher operating profit margin indicates greater efficiency in generating profit from core agricultural activities.
The operating profit margin provides insights into the farm’s financial health and sustainability. It helps farm managers gauge whether operating expenses are well-managed relative to revenue and if the farm is generating sufficient profit to cover operational costs.
Understanding the operating profit margin can also guide strategies to increase revenue. Farmers may explore opportunities to diversify products, target higher-value markets, or improve marketing efforts to increase revenue while maintaining or reducing operating expenses.
For lenders and investors, a margin demonstrates financial stability and operational efficiency, which can enhance investor and lender confidence. It provides assurance that the farm can generate sufficient profit to meet financial obligations and potentially attract capital at favorable terms.
Further Reading
Farm Financial Standards Council – https://ffsc.org/
Basics of a Farm Balance Sheet, Ohio State University – https://ohioline.osu.edu/factsheet/anr-64
Farm Financial Analysis Series: Balance Sheet, Mississippi State University Extension – https://farms.extension.wisc.edu/articles/preparing-a-balance-sheet/