How to use cost accounting to analyze profitability in your grow room
Updated: Nov 3, 2022
EBITDA. Net Income. Gross Margin Positive. Cashflow. Break Even.
What metrics should you be using to determine the success of your growing operation? What kind of measurable results do your investors want? Is everyone on the same page?
A farmer from California once told us that accountants can make up whatever numbers they want, the only important question is: Do I have more money this month, than I did last month? While this is true for cash flow management, cost accounting can play an important role in improving the profitability of your operation. The right metrics provide you with insights and help you improve operations. The wrong metrics, however, can easily lead you down a costly path to disaster. You can only manage what you measure, so you'd better maker sure your measurements are the right ones.
When asking yourself, "How much does it cost to grow this crop?" you may be tempted to reply, “...it depends on yield." But that would not be accurate. The most informed growers realize that real cost is independent of yield and as such, your metrics have to reflect that reality. The following cost accounting tips will explain what we mean.
Step one – Determine the CPS – cost per site.
Determine the number of active plant sites in your grow room. If you choose trays, use the total number of trays. If you use plugs, then use the total number of plugs. You may also use number of lights, number of grow beds, if either fits your growing methodology. At a minimum, try and find the least common denominator across crops. Whatever metric you choose, size should be the same square footage every time. Once determined, calculate the # of active plant sites in your main growing area. The nursery or propagation area should not be counted as a site.
Add up each of your expenses related to growing (direct costs only) and then divide each bucket by the number of plant sites (see #1) in your grow room. This is your cost per site. (CPS)
Closely follow the CPS -- When you add sites or expand production, your CPS should go down. If there are issues in the nursery, and plants are not getting transplanted fast enough, the CPS will likely go up. If your labor is under performing one month, CPS will go up. Avoid using cost/lb or cost/oz becaause production volumes skew the numbers and hide lazy or inefficient workers.. By removing yield from the equation, operational costs can be analyzed on their own merits.
Step 2 – Determine Fixed vs Variable expenses
List your expenses (direct costs) and determine whether they are fixed, semi-variable, or variable. A fixed expense means it is either the same every month, or acts independently of production levels. A semi-variable expense is one that changes with the amount of plants you grow, but is not necessarily dependent on yield, while a variable expense depends solely on yield.
Fixed: Head Grower/Manager salaries; Electricity; Rent; IPM; Safety; Water
Semi-Variable: Seed labor; Transplant labor; Raw Materials; Sanitation
Track these three buckets separately to analyze where improvements are necessary. Determining which are dependent on yield and which are independent, will help you run a more efficient grow room.
*NOTE: Packaging and packaging labor should be analyzed separately, AFTER the costs to produce are measured. The grower should always assume that packaging/processing can be outsourced and that your main job is to produce the best possible crop for the lowest possible price, before it is turned over for post-harvest handling.
Step 3 – Calculate a gross margin for every crop you grow.
Determine number of active sites per crop (CROP SITES)
Allocate Fixed Costs across each crop type proportionate to the number of CROP SITES to determine a Fixed Cost / Unit (FCU) for each crop type.
Allocate labor costs across crop types by implementing a semi-robust, time card program, which allows for tracking of crop specific efforts. Absent this, use the same approach as fixed costs, and allocate proportionate to the number of CROP SITES.
Use sales numbers to determine revenue per crop. (RPC)
Allocate packaging costs and pack labor expenses to each crop type based on the actual direct cost. I.e. you can easily determine cost of packaging because it is a true variable expense.
Understanding Fixed vs. Variable expenses, and initiating a program to track labor by crop, allows the grower to isolate trends, and determine which crops are the most profitable. Yield is already captured in the revenue number, and should not be used to allocate costs across crop type. This will skew your analysis and might lead to incorrect results.