AEC 4204-

Agribusiness
Management
Lecture 6: Agricultural enterprise selection
and management.
Paul Aseete, PhD

October 1st, 2021

Agricultural enterprise selection
and management
• Key Concepts to Learn
1. Profitability and gross margin analysis,
2. Cost analysis
3. Efficiency analysis
4. Input-output decisions
5. Break even analysis
6. Inventory control
Agricultural enterprise selection
and management
• By the end of this module, students should be
equipped with knowledge and skills to
1. Define profitability of organizations.
2. Manage agribusiness projects efficiently and
economically.
3. Calculate Various performance measures:
Profitability and Gross margin analysis, Efficiency
analysis, input-output decisions
4. Appropriately select profitable agribusiness
enterprises
PART 1:
Profitability
and Gross
Margin
Analysis
Profitability and Gross Margin
Analysis
What is profitability?
Profitability is the ability of an entity (business, farm,
cooperative) to make profits.

This ability depends on the consistent difference between

revenue collected and the costs involved in generating this
revenue.

The level of profitability depends on: the ability of the

organization to maximize revenue while at the same time
minimizing costs
Profitability and Gross Margin
Analysis
• For example: a farm involved in raising cattle to produce
milk for commercial purposes.
▪ Such a farm can maximize revenue if it can help the cows to
produce milk to their maximum capacity.
▪ And it can minimize costs if it consistently uses quality
inputs that can be got cheaply.
▪ These two conditions depend on the company's level of
efficiency and effectiveness and capital sources’
combination plus their cost implication in terms of interest,
divided and repayment of the principal
Profitability and Gross Margin
Analysis
• Efficiency: - This refers to using the least level of resources
(costs) to produce the maximum output possible. i.e.,
achieving the stated goals with the least amount of
resources.
• Effectiveness: This is doing the right thing very well and in
time
• Indictors of effectiveness
achieving the pre-stated aims and goals like the level of
output, revenue access to a given market, etc
Profitability and Gross Margin
Analysis
• If a farmer rears 100 chickens for producing eggs for sale he
would expect to have at least 3 trays of 30 eggs each every
day. His farm can be considered effective if it can achieve
that target consistently.
• Also. the farm can be efficient if in the process of achieving
the pre-stated target it has used the least cost input
combination e.g., it has used good and nutritious food in
addition to feeding the chicken with cheap and readily
available natural weeds.
• The overall effect will be that the birds are getting quality
food at low costs.
Profitability and Gross Margin
Analysis
• We should note that the greater the efficiency of the
organisation the higher the level of profitability.
• Profitability therefore is measured as
• a relation to sales hence the gross margin analysis
• in relation to investment.
• Alternatives in production process may consider:-
• Source of raw materials
• Cheaper means to market
• Increase in price of the produce with low proportionate increase in
costs.
• Net profit is Total Revenue minus total cost
GROSS MARGIN ANALYSIS
▪ Gross Margin Ratio And Enterprise Selection
• We often use enterprise budgets with the resulting Gross
margins to calculate profitability
• Gross margin analysis is at times referred to as partial
budgeting. WHY?
• Only variable costs are included in the calculation and the fixed
costs are excluded
• For the same reason it is called Gross margin instead of the Net
margin
GROSS MARGIN ANALYSIS
Gross margin of a farm:
• A “gross margin‟ can be defined as the gross
income from an enterprise less the variable
costs incurred in achieving it.
• It is used to measure the profitability of a
business.

𝑮𝒓𝒐𝒔𝒔 𝑴𝒂𝒓𝒈𝒊𝒏 𝑮𝑴 = 𝑻𝒐𝒕𝒂𝒍 𝑹𝒆𝒗𝒆𝒏𝒖𝒆 − 𝑪𝒐𝒔𝒕

𝑻𝒐𝒕𝒂𝒍 𝑹𝒆𝒗𝒆𝒏𝒖𝒆 = 𝑶𝒖𝒕𝒑𝒖𝒕 ∗ 𝑷𝒓𝒊𝒄𝒆

GROSS MARGIN ANALYSIS
Gross margin ratio (GMR):
• The GMR reveals the profitability potential of an enterprise in
comparison to other enterprises

𝑮𝒓𝒐𝒔𝒔 𝑴𝒂𝒓𝒈𝒊𝒏
𝑮𝒓𝒐𝒔𝒔 𝑴𝒂𝒓𝒈𝒊𝒏 𝑹𝒂𝒕𝒊𝒐 𝑮𝑴𝑹 = ∗ 𝟏𝟎𝟎%
𝑺𝒂𝒍𝒆𝒔

• GMR reflects the efficiency with which management produces

each unit of product.
• High GMR implies high returns relative to the cost.
• For instance, if GMR is 40%, then the cost of production is
constituted by 100-40=60%
GROSS MARGIN ANALYSIS
• Type of costs in production
1. Variable costs
• These are expenses that vary with output within a
production period. For example, if the number of breeding
cows doubles, then the variable costs associated with
carrying the additional stock, such as drench and
vaccination costs, will also roughly double.
• Other examples include expenses for feed, marketing, herd
health, breeding, seed, fertilizer, chemicals, fuel, repairs,
and hourly or seasonal labor.
• Other terms used to describe variable costs include cash
costs (or expenses), direct costs, and out of pocket costs.
GROSS MARGIN ANALYSIS
• Type of costs in production
2. Fixed costs
• Do not vary with the level of output. They include
depreciation, taxes, interest on investment, land charges,
salaried labor, and insurance. Sometimes management fee
also is included as a fixed cost.
• Indirect, noncash, and overhead costs are other terms used
to describe fixed costs.
GROSS MARGIN ANALYSIS
• Type of costs in production
3. Total costs
• Total costs are variable and fixed costs added together.
• While an enterprise should earn a profit above total costs, this
is not always possible. Income received often is less than total
production costs.
• Should an enterprise be continued under these
circumstances? The answer maybe yes if (l) returns are above
variable costs and (2) if it is a short-term condition.
• If fixed costs are not covered in the long run, however,
reinvestment in capital items (such as tractors, implements,
buildings, and equipment) cannot be made and existing capital
stock eventually is depleted.
GROSS MARGIN ANALYSIS
• How can gross margins be used?
The calculation of a gross margin is the essential first step in
farm budgeting and planning.
It enables you to directly compare the relative profitability of
similar enterprises, and consequently provides a starting point
to deciding or altering the farm's overall enterprise mix.
GROSS MARGIN ANALYSIS
• What does one need to calculate gross margins?
• An example of a maize production enterprise:
• To calculate the gross margin for maize enterprise one
needs know:
1. The inputs that go into production of maize
2. Output from the maize crop enterprise.
 GROSS MARGIN ANALYSIS
• The inputs referred to are variable inputs not fixed
inputs.
• The variable inputs include seed, fertilizer, pesticide,
hired labour and hired machinery payments see Table 1
on the next slide.
Cost of an input = quantity of input used x price per unit of the
input
• The output from the maize enterprise mainly refers to
the maize yield (fresh cobs or grains or even fodder)
• Value of output = Farm price of the maize x selling price
per unit.
• The gross margin analysis framework is based on costs
and yields for 1 ha of crop in this example.
GROSS MARGIN ANALYSIS
Table 1: Template for estimating Gross margin for growing
maize (everything is evaluated per ha)
ITEM UNITS PRICE/UNIT QUANTITY VALUE
(UGX)
1. REVENUE
A. Sales Kg
Total Revenue A
2. VARIABLE EXPENSES
(B) Enterprise preparation
B1. First Ploughing (opening land) Ha
B2. Second ploughing Ha
Total land preparation expenses B
(C) Costs of inputs
C1. Seed
 GROSS MARGIN ANALYSIS
Table 1: Template for estimating Gross margin for growing
maize (everything is evaluated per ha) - CONTINUED
ITEM UNITS PRICE/UNIT QUANTITY VALUE (UGX)
C2. Fertilizer (DAP) Kg
C3. Fertilizer (Urea) Kg
C4. Fertilizer (NPK) Kg
C5. Pesticides Litres
C6. Sacs Number
Total Input Costs C
(D) Labor Costs
D1. Planting Man days
D2. First weeding Man days
D3. Second weeding Man days
D4. Fertilizer application Man days
D5. Herbicide application Man days
 GROSS MARGIN ANALYSIS
Table 1: Template for estimating Gross margin for growing
maize (everything is evaluated per ha) - CONTINUED

ITEM UNITS PRICE/UNIT QUANTITY VALUE (UGX)

D6. Harvesting Man days
D7. Shelling Man days
D8. Drying Man days
Total Labor Costs D
Total Variable costs B+C+D
Gross margin (Total
revenue minus total A-(B+C+D)
variable expenses)
GROSS MARGIN ANALYSIS
• Application of Gross margin and Gross margin ratio
in enterprise selection
• Mr. Ssembatya would like to venture into one of the
following enterprises Vanilla, cotton and coffee
given the enterprise costs and returns per ha/ year.
• He, however, does not know which enterprise will
be more viable.
• We can apply gross margin and gross margin ratio
to help the Farmer choose the best enterprise to
venture into.
GROSS MARGIN ANALYSIS
Table 2: Hypothetical production cost, value of sales and gross margin case

Enterprise Yield Farm Value of Variable cost Gross

(kg/ha/year) gate output (Ushs) margin
price(Us (Ushs/ha/ (Ushs/ha/y
hs) year) ear)
Cotton 2,500 200 500,000 137,000 363,000
Coffee 2,000 400 800,000 122,000 678,000
Vanilla 1,000 5,000 5,000,000 140,000 4,860,000

Table 3: Comparison of profitability potential

Enterprise Value of output Gross margin Gross margin ratio

(Ushs/ha/year) (Ushs/ha/year)
Cotton 500,000 363,000 72.6
Coffee 800,000 678,000 84.75
Vanilla 5,000,000 4,860,000 97.2
GROSS MARGIN ANALYSIS
Table 3: Comparison of profitability potential

Enterprise Value of output Gross margin Gross margin ratio

(Ushs/ha/year) (Ushs/ha/year)
Cotton 500,000 363,000 72.6
Coffee 800,000 678,000 84.75
Vanilla 5,000,000 4,860,000 97.2

Conclusion
Since Vanilla has a higher gross margin ratio, then the
enterprise has higher returns compared to coffee and cotton.
The former can there be advised to venture into Vanilla ahead
of cotton and coffee.
 HOMEWORK 1 (10 points)
• Choose one enterprise (crop, livestock, or any other etc.)
that is prevalent in you home district, obtain the cost of
production (detailing inputs and price per hectare),
estimate output from a select farmer per hectare and
calculate their gross margin per hectare.
• Make it as practical as possible
• Present results in table for (preferably use Microsoft excel
if you have access to a computer)
• If handwritten, make it as legible as possible.

(Due date 15/10/2021: 11:59PM)

NOTES: IF EXCEL OR WORD SHARE YOU FILE, IF HANDWRITTEN SHARE A SCREEN SHOT.
 INPUT- OUTPUT DECISIONS
• Agribusiness managers must make a variety of
decisions about the amounts and combination of
inputs they use and what products they must produce
in the production process.
• This is because resources are scarce and therefore,
they must be used in the most effective and efficient
manner in order to maximize profits.
• They must understand the relationship between the
inputs used and outputs produced in the production
process. i.e., the production function.
 INPUT- OUTPUT DECISIONS
• The production function is the technical relationship
between the quantity of inputs used and the outputs
derived from the production process.
• It can be represented as:
1. Statement-eg. Maize yield is function (as a result) of use
of the following inputs in the production process (Land,
fertilizers, seed, etc).
2. Equation eg. Y=b0Xi +e, where: Y= Maize Yield and Xi =
Variable inputs used in the production process. e
represents other factors we may not observe or even
error we make.
3. Graph – See next slide
INPUT- OUTPUT DECISIONS
A production function expressed as a graph
INPUT- OUTPUT DECISIONS
• The production function can best be analysed by
looking at:
1. Total output( Total Product) or Total Physical Product
(TPP)
2. Average output( Average Product) or Average Physical
Product (APP)
3. Marginal output( marginal Product) or Marginal
Physical Product (MPP)
INPUT- OUTPUT DECISIONS
1. Total output (Total Product) or Total Physical
Product (TPP)
• This refers to the output of a commodity resulting from
the use of all inputs in the production process.
• It looks at the contribution of all inputs (Variable and
fixed) to the total output in the production process.
• The shape of the production function (TPP) depends on
the level of efficiency of the technology used in the
production process. The more efficient the technology is,
the higher will be the total output and vice versa.
INPUT- OUTPUT DECISIONS
1. Total output (Total Product) or Total Physical
Product (TPP)
INPUT- OUTPUT DECISIONS
2. Average output (Average Product) or Average
Physical Product (APP)

1. This refers to the output per unit of the variable factor

used in the production process.
2. It measures the productivity (efficiency) of the variable
input used in the production process.
𝑇𝑜𝑡𝑎𝑙 𝑃𝑟𝑜𝑑𝑢𝑐𝑡 𝑇𝑃 𝑌
3. 𝐴𝑣𝑒𝑟𝑎𝑔𝑒 𝑝𝑟𝑜𝑑𝑢𝑐𝑡 𝐴𝑃 = 𝑇𝑜𝑡𝑎𝑙 𝑉𝑎𝑟𝑖𝑎𝑏𝑙𝑒 𝑐𝑜𝑠𝑡𝑠 𝑇𝑉𝐶
=
𝑋
INPUT- OUTPUT DECISIONS
3. Marginal output (Marginal Product) or Marginal
Physical Product (MPP)

1. This refers to the change in the total output associated

with an extra unit of the variable input

𝐶ℎ𝑎𝑛𝑔𝑒 𝑖𝑛 𝑡𝑜𝑡𝑎𝑙 𝑝𝑟𝑜𝑑𝑢𝑐𝑡

2. 𝑀𝑎𝑟𝑔𝑖𝑛𝑎𝑙 𝑝𝑟𝑜𝑑𝑢𝑐𝑡 𝐴𝑃 = 𝐶ℎ𝑎𝑛𝑔𝑒 𝑖𝑛 𝑡ℎ𝑒 𝑣𝑎𝑟𝑖𝑎𝑏𝑙𝑒 𝑖𝑛𝑝𝑢𝑡𝑠
=
INPUT- OUTPUT DECISIONS
• Table 4: Relationship Between TP, AP, MP
Variable Input (X) TP 𝑇𝑃 ∆𝑇𝑃
AP = ( 𝑋 ) MP (= )
∆𝑋

1 4 4 4
2 10 5 6
3 21 7 11
4 40 10 19
5 55 11 15
6 60 10 5
7 63 9 3
8 64 8 1
9 63 7 -1
INPUT- OUTPUT DECISIONS
Relationship Between TP, AP, MP

Consider first the TP curve. As

labour is increased relative to
the fixed inputs, TP curve rises
rapidly, reaching its maximum
slope at point F. Up to point F,
TP rises at an increasing rate.
Thereafter TP starts to decline
(increase at a decreasing rate).

A typical TP curve thus shows

that it rises initially slowly,
then more rapidly and then
more slowly again until it
finally reaches a maximum and
begins to decline.
 INPUT- OUTPUT DECISIONS
Relationship Between TP, AP, MP

Note that points below the TP curve

are inefficient and points above the
TP curve are unattainable.

In this sense, TP curve has the

similarity with the production
possibility curve that separates the
attainable as well as efficient output
levels from those of unattainable
levels of output.
 INPUT- OUTPUT DECISIONS
Relationship Between TP, AP, MP
Points on the TP curve are thus
efficient.

MP is the slope of the TP curve.

Thus, the maximum slope of TP
(i.e., point F) must correspond to
the maximum on the MP (point R).

Once the employment of labour

crosses this point, TP increases at a
diminishing rate. When OT unit of
labour is employed, AP becomes
maximum.
 INPUT- OUTPUT DECISIONS
Relationship Between TP, AP, MP
Beyond OT units of labour
employed, TP continues to rise, of
course at a diminishing rate, and
reaches maximum at point K.

Here the slope of TP becomes zero

since TP is constant and, hence, MP
becomes zero (corresponding to ON
volume of labour employed).

Beyond ON, if labour is employed,

TP will decline, and MP will become
negative.
 INPUT- OUTPUT DECISIONS
• The relations among TP, AP and MP are used to define three
stages of production:

• Stage I is known as the stage of increasing returns where TP

increases at an increasing rate and, hence, AP and MP rise.
However, MP exceeds AP throughout this stage.

• Stage II is called the diminishing stage since both AP and MP decline

but are positive. This is the most crucial stage as far as the decision
to produce is concerned.

• Stage III is called the stage of negative returns where TP declines

and MP becomes negative.

• The above discussion will help us to show (i) the relationship

between AP and MP, and (ii) the three stages of production in a
nutshell form.
 HOMEWORK 1 (10 points)
• Plot the information in TABLE 4 in graph and show
the following regions (stages of Production):Stage I,
II, III
• Show the relationships between TP, AP, and MP in
the various stages of production. Give brief
explanations

(Due date 22/10/2021: 11:59PM)

NOTES: IF EXCEL OR WORD SHARE YOU FILE, IF HANDWRITTEN SHARE A SCREEN SHOT.
 Next lecture
• CHOOSING THE MOST RATIONAL LEVEL OF INPUT USE
• BREAK EVEN ANALYSIS
• Practice examples in EXCEL