March 20, 2001
DO YOU REALLY NEED TO KNOW PRODUCTION COSTS?
Recently, a number of individuals have been stressing the need for farmers to
know their per bushel costs of producing corn and soybeans. Much of this current
emphasis revolves around developing marketing plans under which farmers set pricing
objectives based on their break-even cost levels.
Break-even cost levels may aid in developing a marketing plan. However, there
is a problem in that market prices may not reach break-even levels, as has happened
with corn and soybeans over the past three years. Moreover, per bushel production
costs are not known until after harvest when yields become known. Obviously, higher
yields lead to lower production costs while lower yields cause higher production
costs. Rather than basing it on production cost levels, a successful marketing
plan is more likely based on assessments of current market conditions and risks.
Why Know Production Costs?
The benefits of knowing production costs accrue over time and impact farm businesses
indirectly. Perhaps the most important reason for calculating production costs
is to close the control loop. Many farmers prepare budgets prior to planting to
aid in production planning. Determining how close actual costs come to budgeted
costs needs to be done to see how well the planning process works. It might be
possible, for example, to plan for a low corn herbicide cost of $20 per acre.
If, however, corn had to be re-sprayed causing herbicide costs to rise considerably.
In this case, the herbicide program becomes questionable, particularly if actual
costs consistently exceed planned costs over several years.
Per acre production costs also vary considerably across farms. These variations
are important when preparing projected cash flow statements. Most programs used
to project cash flows rely on per unit production costs (e.g., per acre costs
for fertilizer, seed, etc.). Using unreliable production cost estimates, such
as those coming from averages across many farms, will result in faulty cash flow
projections for an individual farm. Some of the most reliable costs estimates
for an individual farm are the averages of that farm's previous years' costs,
adjusted for changes in input prices and input usage.
The range in production costs across farms suggests that comparing actual farm
results to averages from a group of farms or other benchmarks is useful. These
comparisons will identify strengths and weaknesses of a farm operation.
Calculating Production Costs
Calculating production costs involves extensive calculations. Also, judgments
on how to split machinery, overhead, and interest costs across enterprises must
be made. A Microsoft Excel spreadsheet, called Enterprise Allocation (E-allocate),
has been developed at the University of Illinois to aid with calculations and
to provide guidance in splitting costs. E-allocate is available for download at
farmdoc (www.farmdoc.uiuc.edu). It
is in the finance section under FAST tools (www.farmdoc.uiuc.edu/finance/business.htm).
E-allocate takes whole farm costs and aids users in allocating those costs to
crop, livestock, custom farming/work, and other enterprises. E-allocate allows
users to allocate dollar amounts directly to enterprises. E-allocate will also
allows costs to be allocated to enterprises using indirect methods. Indirect methods
for crops include allocations based on Illinois crop budgets, operator acres,
tillable acres, and percent of revenue received from the crop. The final product
of E-allocate is a series of reports listing revenues and costs for a farm's enterprises.
Average Costs for Corn and Soybeans
Average per acre costs of producing corn and soybeans are available for comparing
to an actual farm's costs. These costs are summarized yearly from farms enrolled
in Illinois Farm Business Farm Management (FBFM). Averages exist for different
regions in the state:
1. Northern Illinois,
2. Central Illinois for
farmland with high productivity,
3. Central Illinois for
farmland with low productivity, and
4. Southern Illinois.
Comparisons of actual to average costs will likely identify strengths and weaknesses
of an operation.
Issued by:Gary Schnitkey,
Department of Agricultural and Consumer Economics