Dick Wittman: importance of managerial accounting

Narrator: Hey podcast, somewhere along the way we missed that it is our 100th episode. We just wanted to say thank you to everyone for listening. We've really appreciated all the wonderful feedback and we hope that we just continue to provide great value to you. Enjoy today's podcast with Dick Whitman. Have a great week, everyone.

Chris

Barron: Welcome everybody to another episode of the Ag View Pitch, and today we're gonna have a little conversation about accounting. And I've got here expert Dick Whitman from Washington— well, actually Idaho. And he's basically here at our peer group meeting in Las Vegas, and we are talking about using managerial accounting for financial analysis and strategic thinking. And there's not a lot of strategic thinking that goes on here in Vegas, but we've been working on it here for a couple days, haven't we, Dick?

Dick

Wittman: How's it going? We have been.

Chris

Barron: So tell the listeners a little bit about, you know, what you've been talking to our peer group about here in the last couple of days and what you've been trying to educate us on to make just better decisions with managerial accounting.

Dick

Wittman: Well, the focus of this is not on accounting. It's more on what are the areas that we make decisions in, in a business, and how do we do a better job of designing the right information that will help those decision makers optimize the decisions they make. And so managerial accounting is a way of defining the kind of information that responsibility managers or segment managers that are managing a part of the business, they— what is the information they need to see how well they're doing their jobs? And then based on the information that they can review and analyze, how do we identify better strategies for improving performance in these individual areas, whether it's in agronomy whether it's in managing our equipment maintenance and operations, whether it's in marketing or finance.

So the whole idea of management accounting is breaking the business up into management segments where we, we match information systems to areas in the business that people manage and then give them good feedback on information and decisions that they control.

Chris

Barron: Yeah, because that's really one of the big issues that I think you probably see, right? You go to a farm operation and maybe there's 4 or 5 profit centers and, you know, you blend in the expenses among all of them, you know, the labor and repairs and whatever it might be for additional expenses, but then getting those expenses allocated correctly, you know, what are some of the recommendations there and how do people get started, you know, to get those expenses allocated in the right bucket so that you figure out, okay, this profit center in our business maybe is a cost reduction center as opposed to a profit center, and maybe another portion of the business is truly a profit center. So talk to us a little bit about that.

Dick

Wittman: Well, first of all, we have a tendency to, as people managing bank accounts, anything that comes into a bank account we always consider as revenue and anything going out as an expense, when in fact we need to be focusing more about what is our primary commodity that we're in business to produce and sell for a profit. And if we identify that, a lot of things that come in as revenue are not really revenue at all. Government payments, refunds on gas tax, cost recovery from the sale of byproducts. These are things that generate revenue, but they aren't part of our commodity revenue. They're just an adjustment to cost. Oftentimes we have excess capacity in our business, so we go and do a little bit of custom work, a little custom fertilizing, or maybe some custom trucking, but we're not really in the trucking business. The neighbor just wants us to do something.

Well, there's costs associated with doing that, that are already buried in our labor and our fuel and our machinery costs, that revenue is not commodity revenue. That's, that's cost recovery that needs to be brought back into our accounting structure as a reduction of cost. Because what we're wanting to know as a marketer is what is my net cost of the products that we've created for sale, and how do I go out on the market and set a reasonable target for a margin and then market accordingly. So if we don't properly account for things, we tend to overstate our cost structure. We set artificially high targets for marketing at a profit, and oftentimes we don't ever get that target reached, so we don't sell.

Chris

Barron: So we're a high-cost producer, and maybe we're not a high-cost producer in a lot of cases.

Dick

Wittman: We found many of the people that go through these workshops are overstating costs by as high as 15 to 20%. So just the not proper procedures for addressing some of these cost adjustment items.

Chris

Barron: So if we think about this, so you know, you take the MFP payment, for example, that's a government payment that came into U.S. farmers this year on a per-county basis. So what you're saying then is instead of putting that as additional income in there, would that be a cost reduction as a specific example?

Dick

Wittman: It would, but a more— probably a better example of that would be was when we used to get these direct payments to farm regardless of what crop we produced. That was— had nothing to do with commodity revenue. It was basically, you left to look at that as an adjustment to your cost of rent or your cost of land. So bringing that into the— your accounting system as a cost adjustment looks— then you look at what the net costs are in the business that you have to capture out of the market, and you can go out of market accordingly. What if you did a conservation project where you got a 50% cost share from somebody to help put that in? You don't put the revenue for that cost share up in your revenue. It comes back into your management accounting system as an adjustment to cost.

Because it's that net cost after the revenue, after the cost sharing that's still got to be covered in the market. Okay. Okay.

Chris

Barron: Well, you know, talk to me a little bit too about some of the other topics that we discussed at this event, you know, that you think are important the listeners should be aware of. You know, when we're thinking of managerial accounting, you know, what are some of the other components that are important?

Dick

Wittman: Well, when we break down some of the factors of production, one of our huge costs is our overhead costs related to labor and machinery and equipment. And many of us are not optimizing the decisions daily on machinery equipment because we don't know how to break it down into a— what is the cost of owning versus the cost of leasing, or the cost of acquiring that resource through a joint venture or a collaborative arrangement. And on large-ticket items, I'm a firm believer that we need to have an analytical model that's allows us to look at all those options and choose that option that helps to optimize the cost decision. Many times we own a machine where we should be renting it or sharing it, where we're leaving $20,000 to $30,000 of opportunity cost on the table.

And sometimes we need excess capacity due to weather or qualitative reasons, but when that number is so large and we have ready access to all those alternatives, we're just wasting money and we're doing something because we think we can afford it as opposed to it's the most optimal financial decision.

Chris

Barron: Right, so what's a practical approach to achieving or to analyzing those numbers? What, what system do you recommend or where do you recommend to look at that?

Dick

Wittman: There's a number of analytical models. My favorite is the Kansas State Ag Manager program where you can simulate given your cost of a piece of implement and your operating costs. You can go in there and calculate what it costs per acre. You can also do simulations on what it would cost to lease versus purchase. Illinois has in their FarmDocs and models where you can do some of those same things. We should be able to sit down with our financial consultants or accountants or local farm management specialists and work through those same models. But don't just sit at home and say, "Well, it's too complicated, so I'm not even gonna look at it." because you might be overlooking the opportunity to save $10,000, $20,000, $30,000 on a $400,000 or $500,000 equipment investment.

Chris

Barron: Exactly. And to your point, you know, machinery and equipment, and as we look at it through Ag View Solutions, it's typically the second largest line item expense next to land. And so, you know, you made a comment, I think, in the conversation here in the program in the last couple of days that You know, we can as producers spend a lot of time focusing on some of the smaller line items, you know, whether it's insurance or crop protection or seed and some of those things. When in fact, you know, if you look at the, as a percent of the cost of production, land and equipment, you know, if we can improve those just by a little bit, it has a much bigger impact on the bottom line than some of the others. Talk to me a little bit about that specifically, you know, what are some of the analysis structures that you like to use on, say, land, for example?

Dick

Wittman: Well, let's go back to the bigger picture of doing strategic simulation, trying to look at strategic improvement. If we can break our business into manageable segments and then we can start saying, well, what if I did this something in a different way? And how do we quantify whether we're going to grow the business or we're going to look for a more cost-effective way to do something or maybe share something that we've always done on our own. We should be able to take those strategies and financially simulate what happens to our financial structure if we were to do that. What changes in assets? What assets do we add or subtract? What liabilities do we get rid of? How does income and expense change? Then once we have that information, we can complete a partial budget.

We can put it into something like the DuPont model that shows what our baseline performance is now and how it will change ROE or ROA to the better or the worse. And people are blown away sometimes by seeing how a relatively innocent change or strategy can actually have a huge impact on ROE. By making us more cost efficient or by generating more revenue in relation to the assets.

Chris

Barron: Yeah, we've got some laughers in the back here. We're in Vegas, so I guess we get that. Anyway, we'll continue on here. So if you had some other things that you'd like to talk about, do you want to hit on those? We got this fun laughing guy in the background here, don't we?

Dick

Wittman: So— Well, there's an array of issues from equipment optimization to— another key area in this is helping the marketing managers have a better foundation for how they know what their targets are. And by having good cost accounting and getting a really accurate cost of production, We can go into marketing programs with a good base of what it has been historically. A management team can sit down and say, what's a reasonable target for the margins we hope to achieve? If we can draw a graph that shows here's our cost of production expectation, here's our, our target margin, very rarely does the market not give us a chance throughout the year to achieve that market. But if we don't have a goal-directed plan for marketing, oftentimes we're our plan is hope for the best. And when we hit it, we don't know that we've reached a goal because we haven't set a goal.

And so we don't pull the trigger. Next thing you know, we look back on an opportunity that we go, well, wow, I had a 25% margin locked in there if I had taken it, but I didn't know my cost, so therefore I didn't know what a 25% margin would be. So consequently, I didn't pull the trigger on an opportunity.

Chris

Barron: And that's a great comment. If we can set those parameters, then the next step though is being disciplined, right? It's actually applying the principles of what you've been teaching for the last couple of days here, of, you know, the discipline behind it. But the results are a more profitable business, right? It's what's going to keep us in business when these margins are so tight and we get that one or two opportunities throughout the year. If we don't take advantage of them when they're there, and look at them as a margin target as opposed to, you know, chasing a price. You know, then we actually have a target, and it's no different than you would go out and we go shoot some guns, right?

Narrator: Right.

Chris

Barron: We're just going to shoot in the air, or are you going to have a target before you start shooting? And so you know what you're, what you're aiming for.

Dick

Wittman: So the interesting point, 20 years of teaching at the TPAT program, the data that people have brought into that class profiling their financial performance has shown that operating profit margin as a key metric has probably ranged anywhere from 7 or 8% to maybe as high as 20%. The median number in this class year in and year out. So when you think about that, if some of our best producers are performing in a range of 10 to 20%, and you and I sat down and said, well, what, how, how well would we be long run if we could achieve every year a 20% operating margin in our marketing, we're probably going to be at the top of the top.

Chris

Barron: We'd be the top.

Dick

Wittman: We would be the top of the top. And it would match the best that I have seen in 20 years of data coming in from a large group of farmers. So why would we not set these targets and be more disciplined of saying, if we just do that year in, year out, we're going to be in business. Rather than thinking, well, I'm going to leave some profit on the table if I do this, and maybe instead of 20 or 25, I could get 30 this year. Sure, we would like to get that, but we start with the bull draft process that's based on the knowledge of our base cost, and that's oftentimes just non-existent. And in the absence of that, we market in an atmosphere of fear, right? Fear of not knowing what the number is and fearing that we have to get the highest price price possible to survive.

Chris

Barron: Right, yeah, and that's, that's a real key thing. So one other thing that I want to touch on before we wrap up here is we talked a little bit about accounting programs, and you and I have talked offline a little bit, you know, when we work with producers on Profit Manager, sometimes we really struggle because, you know, they have good accounting systems, but what they don't always have great accounting systems in terms of financial standards are probably pretty sketchy at best in a lot of cases.

And so, you know, if a producer was to look at different programs out there, what are some of the programs— I know you had a chart up that kind of showed what the percentages are, you know, that growers use, you know, based on what you see, what are growers using and what are, in your experience, some of the best programs that have been useful to meet these objectives that we've talked about the last couple of days?

Dick

Wittman: Well, in the years of teaching, we profile these classes every year on what they are using, and then we've statistically tracked that for 20-some years. Between 45 and 50% of these producers, year in and year out, are using QuickBooks. The next highest is, is the Red Wing software, the CenterPoint software that they produce, and it's probably the the most versatile and most popular in the, in the ag space for doing higher-level ag accounting and being able to go beyond tax accounting to do cash versus accrual and cost versus market value. And some of these things you really need to get management information. It does it very well. FBS Systems is also the other high-level functioning ag software that's out there. Most of the other software products out there fall way down in terms of popularity and widespread use. QuickBooks, what it does, it does well. It just doesn't do much.

And the reason people do it is because the accountants love it, it's cheap, and, and they can do their tax returns. But it does not enable you to do the many of the next levels of analysis that you need to run a professional business.

Chris

Barron: Sure.

Dick

Wittman: And if accountant that can help you take your foundation with QuickBooks and export that into spreadsheets and build these other items, that's great. But most of the time, there's an awful lot of doubling up of data entry and a lot of ways for errors to occur.

Chris

Barron: Okay, well, I appreciate you, you know, with all your experience with all those systems and things, it's really nice to talk to somebody that sees a lot of that and can kind of give us some insight on kind of what programs are out there and kind of, kind of what you're seeing. So One final thing, you know, if growers would want to check out your website or be able to get a hold of you, what's the best way to go about that?

Dick

Wittman: They can just go to Wittman Consulting and www.witt.com, and there are a number of free downloads. There's a lot of articles, there's a lot of managerial accounting information in there, there's a lot of family business management type resources there. So we're dedicated to helping people make that transition to a professionally managed business. Great. And that's our goal or our mission.

Chris

Barron: Well, that's awesome. And we really appreciate you not only being here for the podcast, but we appreciate the last couple of days here in Vegas. You know, when you come to Vegas and you tell people, I'm going to Vegas, and they're like, oh yeah, have fun. And we're like, well, we're going to go and talk accounting for 2 days. And it's almost like people don't believe you, right? You know, so I'm sure you experienced that too.

Dick

Wittman: So, absolutely.

Chris

Barron: So most people don't come to Vegas and do accounting. They push buttons and hope for the best.

Dick

Wittman: Well, thank you for what you do as well. I think we, we're very fortunate to have people that are pulling farmers together in these peer groups because they are learning together. They're providing an accountability mechanism to execute that is really getting things done and implemented in a way that I haven't seen in a long time.

Chris

Barron: Yeah, well, I appreciate that. And it's definitely fun. And I mean, these peer groups, you know, it just elevates their professionalism and their business decision-making really improves. And having people like you here to do that, to help with the information is really a big deal. So again, thanks a lot, Nick. We appreciate your time. And thanks a lot everybody for listening to this episode of the Ag View Pitch, and we will catch you next time.

Narrator: Thanks again for listening, everyone. If you would like to hear more content from Ag View Solutions, listen to our other podcasts such as Dad's Wisdom or our Current Harvest series. Ag View Solutions works as an integral part of operations like yours, side by side for farm profit management, business collaboration and structuring, facilitating industry-leading peer groups, and coaching and consulting tailored to your farm's unique needs. We know that no two farms are the same, and we are here to help make your farm be the best it can be. You can learn more at AgViewSolutions.com, email us at AgViewPitch@gmail.com, or call Chris Barron at 319-533-5703. We really look forward to talking with you.