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March 20, 2001
FEFO 01-06

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

  

Department of Agricultural and Consumer Economics    College of Agricultural, Consumer and Environmental Sciences
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