Cost of Production as a Management Tool
Farm Business Management Update, February-March 2007
By Bill Whittle (firstname.lastname@example.org), Extension Agent, Farm Business Management, Page County
The production unit of a farming enterprise is a weaned calf, 100 pounds of milk, one bushel of grain, one ton of silage, one quart of strawberries, a dozen ears of sweet corn, one ticket for the corn maze, or any other end product of your labor. Often the unit of production is what you sell, but it can be an intermediate step such as silage that will be fed to cows. Profitability and sustainability of your farm is determined by what it costs to produce that unit. Cost of Production (COP) of your unit is the basis for virtually all management decisions. Without knowing your COP, most financial management and marketing decisions are relegated to hopes and wishes. Decisions to expand or shrink the farm, hire labor, use custom operators, buy or raise feed, purchase equipment, or even spend money on maintenance are dependent on knowing the COP. Hobby farmers may not need to worry about their cost of production.
Determining your COP could be as simple as dividing your farm expenses by the number of units you produced. Unfortunately this simple calculation is often muddied by the way we typically farm in the Virginia. Most farmers have multiple enterprises that use similar inputs; consequently, you seldom have an accurate record of production. An example is a dairy that raises its own silage. The farmer knows what the seed corn costs, but when fertilizer is delivered it often will be spread on corn ground, small grain, beans, and pasture. The farm gets one bill, but to determine COP, each intermediate enterprise must be assigned its share of the expense. The same is true for the time a tractor is used. Another often overlooked item is labor costs including management costs. Decisions need to be made to assign each enterprise its fair share of expenses. At harvest, you know that you have a full silo or X loads, but harvest quantity is often a guess even if it is a good guess. A ballpark figure of expenses and production is useful, but in today’s tough competitive climate of infinitesimally small profit margins, close is not good enough. For the typical family farmer, who handles your own record keeping, assigning inputs to an enterprise can be both difficult and time consuming until you develop a plan for such allocations.
One potential plan would be to decide which enterprises you are going to track, then assign each a percentage of usage: labor, management time, fertilizer, and farm overhead such as maintenance of the roads, etc. The percentage used would probably be different for each input and should be viewed as a number that is refined over time. An example using corn silage would be to assign it 15% of farm labor for planting and harvesting, 65% of the fertilizer bill, and 30% of tractor expenses. At harvest you need to weigh several wagonloads and then use your experience to calculate total production. This process will provide a better COP for your corn silage and will allow you to make an informed decision whether to raise it yourself or purchase silage from the farm down the road. On a more comprehensive scale, if you, as a dairy farmer, determine the COP of each enterprise, you will have a basis for decisions such as expansion, contracting heifer-raising, or even changing enterprises. Without knowing the COP, too many decisions are decided on an “I’ve got to do something” philosophy.
Determining COP is not easy, but it is a solid management tool that will assist with the sustainability of the family farm. Whether you use a shoebox or computer, records are the key for calculating COP. Without financial and production records, COP will be next to impossible to calculate. For 2007 resolve to become a better record keeper, and then do the hard work to determine your farm’s COP and the profitability of your farm.
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