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Knowing Your Cost Of Production Can Lead To Sound Management Decisions

Knowing your cost of production has always been important. But in today’s agricultural environment, it is imperative to your viability and financial success. Your cost of production is the foundation to a good marketing plan and to buying the right level of crop insurance coverage.

It also helps you determine where you might need to make adjustments to reduce costs and identify opportunities to grow your business.

The scenario of “Joe Farmer” helps illustrate the power of knowing your cost of production. Producers who understand their costs will be in a better position heading into 2018 – and will be well prepared for discussions with their Frontier Farm Credit financial officer and crop insurance agent.

Meet Joe Farmer

Joe is an farmer with 1,000 acres evenly split between  soybeans and corn. He owns 250 of the acres, with an annual land payment of $100,000. Rent on the remaining land averages $300 an acre. His actual production history is 190 bu/acre for corn and 55 for beans.

Joe farms full time while his wife works off the farm earning $30,000 a year and benefits. They spend $80,000 a year on family living expenses. Their next largest cost is an annual farm machinery payment of $75,000.

The cost-of-production worksheet, located at the bottom of this article, gives Joe a better understanding of his operation. (All numbers are hypothetical and do not reflect the actual range of expenses and diversity of production found from one operation to the next.)

Focus on Costs You Can Control

Based on Joe’s current situation, the operation’s break-even costs per bushel are $4.03 for corn and $10.20 for soybeans. These are, of course, higher than current market prices. So what’s Joe to do?

One option is to work on reducing variable costs – and the good news is that fertilizer and other variable costs have inched down in price.

However, fixed costs are the main factors that separate high-, medium- and low-cost operators. The big three fixed expenses include land – cash rent and/or principal and interest payments on owned acres – machinery and equipment and family living. By lowering these costs, you can improve your operation’s overall cost structure.

Adjusting fixed costs is a smart strategy that will benefit every producer. For some, it will help them survive the low prices. For others, it will position them to take advantage of opportunities. If your fixed costs are high, work with your lender to identify strategies that will make you more competitive. The pace of adjustment is critical.

Joe addressed his fixed costs by re-amortizing his land loan to reduce the annual payment to $70,000, renegotiating cash rent to an average of $280 an acre and trimming $10,000 from family living.

VARIABLE COSTS Corn Soybeans LAND COSTS
Seed $110.00 $35.00 Land Payment per Acre $400
Fertilizer $100.00 $0.00 Tax Payment per Acre $20
Lime $0.00 $0.00 Average Cash Rent per Acre $300
Herbicide $35.00 $20.00 Average Land Cost per Acre $330
Insecticide $15.00 $10.00
Irrigation Costs $0.00 $0.00
Insurance Premium $12.50 $9.00 OTHER COSTS / REVENUE
Miscellaneous $5.00 $5.00 Annual Machinery Payments $75,000
Fuel / Repairs $20.00 $20.00 Machinery Payment per Acre $75
Custom Farming Charges $0.00 $0.00 Annual Family Living Expense $80,000
Drying $0.00 $0.00 Family Living Expense per Acre $80
Storage $8.00 $4.00 Off Farm Income / Other $30,000
Transportation $5.00 $3.00 Off Farm Income per Acre $30
Labor $0.00 $0.00 Combined Cost Impact per Acre $125
TOTAL $310.50 $106.00

Improving Profitability

Joe’s understanding of his cost of production allowed him to make adjustments that improve his chances at profitability. Here is a before-and-after comparison of Joe’s cost of production. Talk with your financial officer to discuss options for addressing fixed and variable costs in your operation.

Before Corn Soybeans After Corn Soybeans
Cost of Production per Acre $765.50 $561.00 Cost of Production per Acre $715.50 $511.00
Breakeven per Bushel $4.03 $10.20 Breakeven per Bushel $3.77 $9.29

Balance Sheet Changes May Bail Out Cash Flow

In today’s agriculture economy, “creative financing” means looking beyond cash flow to put your operation on better footing.

We have developed case studies examining three actual farm operations, all solvent (a positive net worth) but with liquidity problems (insufficient working capital and, in some cases, negative net cash income). Instead of focusing on variable costs, the producers restructured loans, unloaded underperforming assets and applied other “creative” solutions to liquidity problems.

Steve Johnson, farm and agriculture business management specialist with Iowa State University Extension, is presenting the case studies at our free GrowingOn® 2016 meetings scheduled for February 29 in Emporia and March 1 in Seneca and Ottawa. Larry Landholder is one of the featured producers.

Larry owns 1,500 acres and rents 500. His operation is solvent, with net worth of $4.5 million, including $2.5 million in land equity. Net farm income for 2015 was positive at $64,000. However, Larry lacks working capital, which is negative $77,000 ($34/acre), and has two machinery loans with annual payments of $138,000 and one real estate loan payment of $95,000 a year. Suppose Larry trims his input costs by $35/acre. That boosts his income by $70,000 — certainly an improvement. But Larry still can’t meet his machinery payment and he risks reduced yields. And what about next year?

Instead, looking at his strong balance sheet, he could use equity in his land for a new $130,000, 10-year loan to pay off a machinery loan. A new 20-year loan for $800,000 on real estate equity would allow him to pay off the other machinery loan, pay down his operating loan and strengthen his cash position. As the simplified table below shows, working capital would jump from minus $77,000 to $414,000. And while real estate payments would rise from $95,000 a year to $180,000 a year, machinery payments would drop from $138,000 annually to zero. Netted out, that’s $53,000 a year less in debt payments.

Financial categories Status Quo Solution
Working capital -$77,000 $414,000
Machinery/equip. payments (princ + int) $138,000 $0
Real estate payments (princ + int) $95,000 $180,000
On a per acre basis
Working capital per acre -$38 $200
Machinery payment per acre $69 $0
Real estate payment per acre $63 $120

We invite you to attend one of our GrowingOn meetings in eastern Kansas to learn more about how Larry Landowner and other producers are managing fixed cost to better position their operations for success in today’s challenging agricultural economy.