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 hypothetical case of “Joe Farmer” illustrates the power of knowing your cost of production.
Meet Joe Farmer
Joe is an Iowa 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.
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.
