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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

Control Family Expenses to Protect Farm Profits

It’s not what you earn, it’s what you spend. For farm families whose living expenses crept up during the recent run of strong commodity prices, Dr. David Kohl’s words serve as a call to action.

Dr. Kohl repeated the phrase throughout this year’s Side By Side Conference, our annual three-day event for young and beginning producers. Left unchecked, Dr. Kohl cautioned, family living expenses threaten the profitability of farm operations. Top managers are adjusting family living and other costs to ensure they aren’t on the wrong side of agriculture’s widening gap in profitability.

Below are key strategies that Dr. Kohl recommended for taking control of family living expenses:

  • Follow the 60-30-10 rule: Sixty percent of farm profits are invested in improved efficiency; 30 percent goes to a working capital reserve to build liquidity; 10 percent is earmarked for discretionary spending, or family living. Families desiring a higher standard of living might need non-farm income to supplement their withdrawals, he says. But he has advised withdrawing less if families are operating their farms with a debt-to-asset ratio (total farm liabilities divided by total farm assets multiplied by 100) of more than 50 percent.
  • Separate business and personal expenses. Dr. Kohl advises developing a family budget that breaks down costs on a monthly basis. Set aside the budgeted amount, plus 25 percent for unexpected costs.Then stick to the budget.

Our financial officers work with customers to better track living expenses so families are in a better position to set spending goals that are right for them. Contact your local FCSAmerica financial officer if you’d like help assessing how family living expenses affect your farm operation.

2014 Family Living Planner