HOW TO ESTIMATE PROFITS
No man who engages in manufacturing or merchandising knows how much he
is going to make annually during life. Much less does he know how much
he will be worth when he dies. Neither does the man who works for a
salary or practices some profession for fees know what his annual
income will be even during the following decade. Neither one nor the
other knows whether he will die a millionaire or a pauper. It is a
problem too complex for any human mind to analyze. It is less certain
than what the weather will be on this day next year, because it is the
resultant of more variable factors.
In some respects there is more hazard in farming than in manufacturing
or in merchandising, while in other respects there is much less. The
profit which may be obtained from farming is neither easier nor more
difficult to estimate than is that of other commercial enterprises.
However, there is no business in which more foolish estimates are made
as to the probable profits, except, perhaps, in mining.
The purpose of this chapter is not to give advice as to possible or
probable profits, but rather to point out the general character of the
data required for any individual problem, where the data may be
obtained and how it may be applied.
There are two forms or methods of stating the financial gain that has
been obtained from farming or other business ventures during a year or
other specific period. The first may be called the interest on the
investment method, and the second the labor income method.
With the interest on the investment method, all expenses may be
subtracted from all the sales. From the cash balance thus obtained the
increase or decrease in inventory may be added or subtracted. This
balance may then be divided by the capital invested, to determine the
rate of interest received.
The rate of interest method is the usual method in the commercial
world. The prosperity of the railroad or industrial concern is judged
by the rate of interest it pays its stockholders on the par value of
the stock. The stock itself takes on the capitalization in accordance
with the present and prospective dividends. The fact that this method
is generally used in the commercial world is evidence that it is well
suited to its needs.
The young farmer who wishes to know whether the operation of a given
tract of land in a certain manner offers him a worthy opportunity will
not find the interest on the investment method the best suited for his
purpose. This is especially true when applied to a single product. For
example, it may be shown that 50 hens will, when properly managed, in
connection with other farm enterprises, return a remarkable interest
on the capital employed. It does not follow, however, that a man can
make a living with fifty hens or even 500 hens. If a man has an
investment of $5,000, on which he obtains 10 per cent, his income
would be $500. If, on the other hand, he has an investment of $25,000
and obtains a return of only 6%, his income is $1,500, or three times
the former amount. In neither case, however, does this form of
statement tell a man how much of his income is due to his brain and
brawn and how much to the capital invested.
What the young farmer wishes to know is how much will he receive for
his own time, energy and skill, after deducting all expenses and a
reasonable interest charge on his investment--such a rate of interest
as he could get by placing his money in good securities or what he
would be required to pay for his capital if he borrowed it. This is
best obtained by the labor income method. With this method all
expenses are subtracted from all sales and to the cash balance thus
obtained is added or subtracted the increase or decrease in the
inventory. This balance may be called the farm income. Thus far the
procedure is just the same as the interest on the investment method.
From the farm income is now subtracted a reasonable interest on the
investment, the balance remaining is called the labor income. This is
the return which the farmer has obtained by and for his own efforts.
If this balance is zero, then he should change his methods or get into
some other business.
This statement of his income, whatever it may be, enables him to
compare his prosperity with that of the man who is employed upon a
salary. Here, again, however, it is difficult to make comparisons
because of the differences in expenses of living. The chief difference,
however, in the expense of the wage earner in the city and the farmer
is in the matter of house rent. For example, if the wage earner pays
$300 a year house rent that must be deducted from his income in
comparing it with the labor income of the farmer. It is often stated
that the farmer also has his living from the farm. This was much more
true formerly than it is at present. Under present methods of
distributing food products and with modern types of farming, the amount
of food supplied the table from the farm is comparatively small. The
rancher in Montana eats foods canned in Maine or Delaware, while the
New Hampshire farmer buys his vegetables from Boston commission
merchants. The Minnesota farmer cannot supply his breakfast table with
oranges, grapefruit or oatmeal. Many of them buy, if not their bread,
at least their flour, and also their butter. The fact that the city man
indulges in high living is no argument in favor of the country man
expecting less wages. Some of those things which are necessary to make
the country an ideal place to live are expensive. Some of them are more
expensive to obtain in the country than in the city, as, for example,
educational facilities. In justifying his purchase of an automobile, a
young farmer recently stated that his wife had certain cares,
responsibilities and even privations which her city friends did not
have. He thought that the automobile would help to offset them.
To my mind there is no more ideal place to live and rear a family than
in the open country when the conditions are what they should be and
may be. I believe, however, it is well to insist that it costs
something to live in the country as well as in the city if one lives
as well as every farmer has a right to expect to live.
Let us now consider the steps necessary in order to arrive at a fair
estimate of the labor income. To make the matter concrete, we will
assume a farm of 200 acres worth $60 an acre located in central
Pennsylvania on a limestone clay loam soil over 1,000 feet above sea
level. This farm is to contain 20 acres of timber, a 30-acre apple
orchard two years old, 40 acres of pasture, 96 acres of cultivated
land divided into six 16-acre fields. The rest of the 200 acres
consists of small yards, roadways and waste land. One-half of each of
the six 16-acre fields is to consist of a rotation of maize, oats and
wheat, each one year, and hay three years, the latter clover and
timothy followed by timothy. The other half is to consist of maize,
barley, followed by alfalfa four years. In the young orchard there
will be grown for a few years potatoes, tomatoes, cabbages and garden
peas. After the orchard attains a size which forbids these intertilled
crops, a portion of the pasture may be broken up so that these market
garden crops may be raised. There will be kept six horses, 20 milch
cows, 20 ewes of some mutton breed of sheep, five brood sows and 50
hens.
First of all, let attention be called to the broad knowledge of
farming required to operate this moderate-sized and comparatively
simple farm. The crops to be raised are maize, oats, wheat, clover,
alfalfa, timothy, potatoes, tomatoes, cabbages, garden peas and
apples. The animal products sold will be chiefly butter fat, wool,
mutton, veal, pork and eggs. This is neither a long nor complex list
of products. They are all adapted to the farm which the writer has in
mind. Yet the man who operates this farm to the highest success will
need to have a knowledge of agronomy, or the raising of field crops,
of horticulture, animal husbandry, including poultry husbandry and
dairying. He needs to have a good understanding of the principles of
agricultural chemistry, to have a knowledge of how to prevent and
combat fungous diseases and insect enemies. To get the most out of his
timber land he should know at least some of the first principles of
forestry, and if he has gained some instruction in the study of
landscape gardening, his home will be more attractive, and his farm a
source of greater pleasure to him.
To proceed with the estimate, the first thing to be done is to make a
record of the cropping system, giving the areas and the estimated
production of each crop. How is the yield per acre to be determined?
Clearly, one cannot afford to estimate his profits on the basis of
some unusual yields. If one could be assured of 40 bushels of wheat,
60 bushels of oats, five tons of hay, 300 bushels of potatoes, or 200
bushels of apples per acre, or 500 pounds of butter fat per cow, or
150 eggs per hen per year, there would be no difficulty about
obtaining a snug labor income. Such results are possible and are
appropriate ideals for which to strive, but are not safe as estimates
on which to do business.
The year books of the United States Department of Agriculture contain
the annual estimate of the yields, and the average December farm price
of staple crops by states. These figures may serve as a basis for
making estimates. If the natural conditions are about the average
stated, one may properly assume that he can obtain an increase of 50%.
He may even hope to double the yield, although it is not safe to
assume such an increase in making an estimate of profits. If the
natural conditions are more favorable or less favorable than the
average, he must take the fact into consideration in his estimates. In
the same way he may consider whether the average December farm price
represents fairly his expectation of the price, or whether because of
favorable location or superior quality of the article purchased he can
expect higher remuneration.
It is here assumed that the young farmer is himself going to be more
than an average farmer. If he is not he will only get average results,
in which case his labor income will be only that of the ordinary day
laborer.
To repeat the idea in concrete terms. If the young farmer is located
in central Pennsylvania and finds that the average yield of wheat for
the state is 17 bushels an acre, he may safely estimate that his
improved methods will bring him 25 bushels of wheat to the acre. He
may even hope for 34 bushels per acre. At the Pennsylvania station
several varieties of wheat have, during the past 18 years, averaged
over 30 bushels per acre. One year one variety produced 43 bushels. It
would not be safe, however, to use such figures in estimating profits.
Having outlined the cropping system and made a careful estimate of the
total annual production of each crop, the next step is to determine
the amount of food and bedding required for the live stock. From this
data it may be determined what products will be available for sale,
and what foodstuffs must be bought. Thus, it may be found, for
example, that the amount of oats raised just meets the requirement,
while more maize must be purchased, together with nitrogenous
concentrates, and that a portion of the hay is available for sale. In
the farm under consideration there will, of course, be wheat,
potatoes, tomatoes, cabbages, garden peas and the animal products
previously mentioned for sale, and later there will be apples and some
lumber from the wood lot.
The data are now at hand by which to estimate the total receipts.
Having made the estimates of receipts, the expenses are estimated, and
the difference gives the cash balance, if there is any. The most
important items of expense will be labor, feed, seeds, fertilizers,
harvesting and threshing expenses, spraying material, shipping
packages, blacksmithing and repairs. After all expenses that can be
thought of are included not less than 10% should be added for
incidental expenses.
The amount of commercial or natural fertilizers to be purchased is, of
course, related to the yard manure which will be produced on the farm;
therefore some estimate of the probable amount is desirable. In a
roughly empirical way the amount of manure produced may be estimated
at twice the amount of dry food and bedding used, provided it is
hauled daily to the field. Where stored and drawn to the field at
stated periods, the shrinkage in weight, although not necessarily in
plant food, may be as much as one-half.
The estimate of what the inventory should be at the beginning and end
of the year is not so simple a matter as it may at first seem to be.
The purpose of taking the inventory is twofold: First, to determine
whether the inventory has increased or decreased, and second, to
determine on what amount of capital interest is to be calculated. For
example, one must carry forward each year seed for the next year's
crop. Feed must be carried over to feed live stock until other food
becomes available, and there must be money on hand with which to pay
for labor unless there is a cash income from the sale of products
sufficient to care for the labor bills.
In the case of the farm under consideration there is a young orchard
of about one thousand trees. This orchard is not bringing in any
income, but there is a constant expenditure of money on it, and a
constant increase in its value. While, therefore, it decreases the
cash income it increases the farm income and the labor income. On the
other hand, it increases the interest charges because the plant or
farm is increasing in value. How much will it increase in value? In
some sections it is customary to consider that an orchard increases in
value $1 per tree per year. If this is a correct estimate, this
1,000-tree orchard will increase the value of the farm $1,000 a year
until it comes into full bearing. The farm under consideration was
purchased two years ago for $9,500. On the assumption just stated, at
the end of 15 years from date of purchase this farm should be worth
$25,000, at least $15,000 of which will be due to a 30-acre orchard.
This is at the rate of $500 an acre for the orchard itself.
In order to bring out some of the phases of the inventory more clearly
the following classification of items is given below:
INVENTORY
A. PLANT.
The real estate, 200 acres at $60 per acre.
The live stock.
Work horses and breeding stock.
Machinery.
B. MATERIALS.
Seeds, potatoes, oats, maize, wheat.
Feed, hay for cattle and sheep, silage for cows, maize for
pigs.
Growing wheat, 8 acres at $6 per acre.
Live stock, calves, lambs and pigs.
C. SUPPLIES.
Hay and oats for horses.
Money for current expenses.
In estimating the inventory at the end of the year, a deduction should
be made for the decrease in the value of the live stock under the
plant and also for the machinery. Perhaps 5% for the live stock and
10% for the machinery and tools will be a fair deduction. Under
materials and supplies those items have been inventoried which are to
be carried over each year from the preceding year. In the case of
seeds the amount required must be deducted from the amount sold, or
they must appear as a charge in the expense account. Ordinarily they
are carried over from year to year and thus become a part of the
permanent investment. Since on the farm under consideration there is a
considerable monthly income from the sale of butter fat and eggs, it
may be possible that no allowance will be needed in the inventory for
current expenses, although it is always desirable to carry a bank
account in order to be able to make favorable purchases when
opportunity offers.
As a part of the work in a course in farm management, the writer asked
each student to secure the financial history of an actual farm
covering a period of three years. The financial history of 30 farms
during the years 1901 to 1903, inclusive, and 28 farms during the
years 1902-1904, inclusive, was thus obtained and is given herewith.
SUMMARY OF FINANCIAL HISTORY OF FARMS
Average size of farm, acres 143.21 133
Average area in crops (includes pasture), acres 121.1 112
Capital at end of three-year period $14,009 $8,893
Capital at beginning three-year period 12,962 7,704
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Difference $ 1,047 $1,189
Interest on capital, $13,485, at 5 per cent[B] $ 674 $ 415
Increase in capital per annum 349 396
Average yearly receipts 3,613 2,208
Average yearly disbursements 1,907 1,221
Average yearly cash balance 1,706 987
Average yearly farm income 2,055 1,383
Average yearly labor income 1,381 968
These figures show the application of principles enunciated in this
chapter. A careful reader will have no difficulty in recognizing how
the different items have been obtained. For example, the difference
between the receipts and disbursements in the first column gives the
cash balance of $1,706. The farm income, $2,055, is obtained by adding
to the cash balance $349, which is the annual increase in the capital.
The labor income is obtained by subtracting from the farm income the
interest on the capital at five per cent. The amount of capital is
determined by dividing by two the sum of the inventories at the
beginning and end of the period.[C]
It will be noted that the gross receipts, the expenses, the farm
income and the labor income on these actual farms are all more closely
related to the capital invested than the size of the farm. Thus, on
the 30 farms with a capitalization of about $13,500, the average
yearly receipts were about $25 an acre, while on the 28 farms with a
capitalization of about $8,300, the average yearly receipts were about
$16 an acre. Likewise on the high-priced farms the labor income was
approximately $10 an acre, while on the lower priced ones it was about
$7.
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[B] Obtained by dividing by two the sum of capital at beginning and
end of three-year period.
[C] For further details see Hunt, "How to Choose a Farm," Chaps. X and
XI.