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 Knowledge for the CommonWealth

Farm Expenses: Where Do You Stand?

Farm Business Management Update, October 2001

By Bill Whittle

A profitable operation is your ultimate goal for the farm. You have only two ways to maintain or enhance profitability and reach your goal. One method is to increase income; the second is to control or reduce expenses.

Reducing expenses sounds simple; "Just cut out unnecessary things," but this tactic is seldom easy. Often producers attempt to reduce farm expenses by attacking the wrong expenditures, i.e. the expenses that seem like fluff or whose need is not readily apparent. For example, trade magazines and association dues are the first to go. The little money saved does not materially affect the bottom line nor does it offset the elimination of a primary means used to stay abreast of a fast moving industry.

Reducing expenses to improve profitability involves two steps. The first is to determine your top expenses as a percentage of income. Generally, reduction in the top five expenses for an operation (even by a small percentage) can have a substantial effect on the bottom line. The second step is comparing your operation's top expenses on a percentage basis to similar farms, i.e. the industry average. The industry average provides a benchmark to help you determine if your expenses are unduly out of line.

Calculating expense percentages is simple in single enterprise operations. If you have multiple enterprises you can only determine expense percentages if you are willing to make the judgment allocating expenses among the different enterprises. However, it is worth the pencil or computer time to make these calculations attempting to allocate expenses to each enterprise. If detailed allocated records cannot be generated, a reasonable alternative is to use Schedule F information after depreciation and interest are subtracted from expenses. Tax depreciation is an expense for federal and state tax purposes and interest is very dependent on the life-stage of the farm (ex. new vs. established farm or inherited vs. purchased farm). Single enterprise farms simply divide the expenses for a specific category (e.g., purchased feed) by the total cash expenses and multiply by 100 to put the value on a percentage basis. For multiple enterprise operations, once expenses are allocated to an enterprise, divide expenses for a category within an enterprise by the total cash expense associated with that enterprise and multiple by 100.

Once you identify the five top expenses for your farm, you will know where you need to work to change your farm's bottom line. Industry benchmarks for different enterprises within the Shenandoah Valley are not always available, but when available, these benchmarks help the manager manage the farm's financial health.

Table 1 listed the top 10 expenses for Valley dairy farms for 1999. This data, collected at a Dairy Management Institute, shows that the top five expenses represent over 70% of all expenses on the farm. A dairyman can use this information as a management tool to compare his operation to peer industry averages. An example is hired labor. If your labor cost is 12% of your total cash expenses and your peer industry group average is 7.6%, you know that you are substantially different. You then have the opportunity to decide if your labor costs are legitimate for your farm or if they are excessive.

Keep in mind that just because your top five expenses are different from the average does not mean you are in better or worse financial health than others. These benchmarks are to assist you in determining where and if improvements or adjustments should be made.

Table 1: Top 10 Expenses as a Percent of Cash Operating Expenses for DMI Dairies- 1999
(Interest and Depreciation are Not included)
  Rank % of Total Cash Expenses $/ CWT of Average Price of Milk
Purchased Feed 1 43.5% $5.50
Labor 2 7.6% $0.96
Market & Hauling 3 7.5% $0.95
Repairs 4 6.1% $0.77
Fert, Lime & Chemicals 5 6.0% $0.76
Supplies 6 5.7% $0.72
Vet & Med 7 3.7% $.047
Land Rental 8 3.3% $0.41
Custom Hire 9 2.2% $0.28
Breeding 10 2.0% $0.25
Total Of Top 5 Expenses   70.7% $8.94

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