Determine your production costs
What is more important in determining production costs – cash costs or economic costs? Does it make sense to know both?
This question comes up a lot when it comes to the cost of the company’s manufacturing budget. It is important to understand the makeup of the various production cost budgets in order to use them for decision making and risk management in agriculture.
The University of Nebraska-Lincoln budgets include cash cost per bushel (or unit) and total cost or economic cost per bushel (or unit) in the first place, along with other major cost categories such as operating costs and operating costs.
Operators often want to know their break-even production costs on a cash basis, or, in other words, forecast what price it will take to cover all of the cash costs associated with a given business. Anything we pay in cash when producing crops or livestock is part of the unit cash cost.
Cash costs consist of operating costs such as seeds, feed, fertilizers, pesticides, vet, labor, customs services, fuel, machine repairs and maintenance, and crop or animal-specific expenses such as insurance, marketing, exploration, drying, storage, and materials.
Interest expenses for all or part of the production time in the case of cash outlays for the production of the goods are to be included, especially if borrowed funds are used to settle material input, services and machine operating costs. Up to this point, some agronomists might refer to operating costs as variable costs, that is, expenses that vary with production over a period of production.
After cash operating expenses, cash overhead expenses such as farm accounting, liability insurance, farm or ranche general operating expenses, and vehicle expenses should be calculated and allocated to the various farm or ranch business budgets.
A cash overhead that cannot be overlooked is property tax if the land used for the production of the company’s raw material is owned. If the land is not owned, the operator’s cash rental cost is an important present value to consider.
In times of tight margins, farm and ranch businesses may only forecast income enough to cover cash costs. In the short term (one to three years) it can be profitable for an operation to just cover the cash costs.
In the long run
In the long term (over three to five years) income is needed to cover all production costs. Business enterprise budgets, as shown in the example, include projections to cover all costs, including operating and overhead costs, as we discussed earlier, plus property costs for machinery and equipment depreciation and opportunity costs, owner labor, and land opportunity costs.
The opportunity cost of work is a value that represents the income that could be generated if the time invested by the owner or unpaid family chores is otherwise employed. Similarly, if the owner-operator had not funded the equity portion of a machine purchase or purchase of other supplies such as fertilizer, that equity could have been devoted to another investment such as stocks and bonds or used to repay the principal of a loan for additional Avoid interest costs. Ownership opportunity cost can simply be the value of what the land could be leased for if it is not farmed by the owner.
It is important to understand what is in the cash cost versus the total economic cost. A break-even price can be determined from each. When capital payments that are not an economic cost are included in a cash business budget, the cash break-even number may be the larger number.
Typically, however, the breakeven point of the business economic budget is higher because it includes a competitive return on equity or opportunity cost, depreciation charge, and owner labor and management fees. Knowing your company’s production costs and various break-even price levels can be a good basis for making timely marketing and management decisions.
The UNL Department of Agricultural Economics and the Center for Agricultural Profitability invite growers and farm managers to use the free online program for calculating the agricultural budget available at. Find agbudget.unl.edu.
The new program enables manufacturers to estimate their production costs based on operating costs, machinery, labor, service and material usage, and property and opportunity costs. A cash and economic budget report can be generated from the inputs into the program, or users can use UNL’s annual harvest budgets that have been entered into the program.
McClure is a Nebraska Extension Instructor and Farm and Ranch Management Analyst.